These 4 metrics indicate that Instalco (STO:INSTAL) is using debt reasonably well
Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Instalco AB (publisher) (STO: INSTALL) is in debt. But the more important question is: what risk does this debt create?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
What is Instalco’s net debt?
The image below, which you can click on for more details, shows that in June 2022, Instalco had a debt of 2.44 billion kr, compared to 1.19 billion kr in one year. However, he also had 497.0 million kr in cash, so his net debt is 1.94 billion kr.
How strong is Instalco’s balance sheet?
The latest balance sheet data shows that Instalco had liabilities of 2.82 billion kr due within one year, and liabilities of 3.22 billion kr falling due thereafter. As compensation for these obligations, it had liquid assets of 497.0 million kr as well as receivables valued at 2.45 billion kr and payable within 12 months. It therefore has liabilities totaling kr 3.09 billion more than its cash and short-term receivables, combined.
While that might sound like a lot, it’s not that bad since Instalco has a market capitalization of 10.3 billion kr, so it could probably strengthen its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Instalco’s net debt to EBITDA ratio of approximately 2.2 suggests only moderate debt utilization. And its high interest coverage of 747 times makes us even more comfortable. Instalco has increased its EBIT by 7.6% over the past year. It’s far from amazing, but it’s a good thing when it comes to paying down debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Instalco’s ability to maintain a healthy balance sheet in the future. So if you want to see what the pros think, you might find this free analyst earnings forecast report Be interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Instalco has generated free cash flow of a very strong 94% of its EBIT, more than expected. This positions him well to pay off debt if desired.
Our point of view
Fortunately, Instalco’s impressive interest coverage means it has the upper hand on its debt. And the good news doesn’t stop there, since its conversion of EBIT into free cash flow also confirms this impression! Given all of this data, it seems to us that Instalco is taking a pretty sensible approach to debt. This means they take on a bit more risk, hoping to increase shareholder returns. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. We have identified 1 warning sign with Installco and understanding them should be part of your investment process.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, do not hesitate to discover our exclusive list of net cash growth stockstoday.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.