These 4 metrics indicate that NKT (CPH:NKT) is using debt extensively

Warren Buffett said: “Volatility is far from synonymous with risk. 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, NKT A/S (CPH:NKT) is in debt. But should shareholders worry about its use of debt?

When is debt dangerous?

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. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.

See our latest analysis for NKT

What is NKT’s net debt?

You can click on the graph below for historical figures, but it shows that in March 2022, NKT had a debt of 228.1 million euros, an increase from 209.6 million euros, on a year. However, he has €118.5m in cash to offset this, resulting in a net debt of around €109.6m.

CPSE: NKT Debt to Equity July 11, 2022

How healthy is the NKT balance sheet?

The latest balance sheet data shows that NKT had liabilities of €1.10 billion due within one year, and liabilities of €362.0 million falling due thereafter. On the other hand, it had €118.5 million in cash and €780.2 million in receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €562.7 million.

NKT has a market capitalization of €1.90 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

NKT has a very low debt to EBITDA ratio of 1.3, so it is odd to see low interest coverage, with last year’s EBIT being only 0.74 times interest expense. So either way, it’s clear that debt levels are not negligible. We also note that NKT improved its EBIT from last year’s loss to a positive result of 11 million euros. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether NKT can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, NKT has burned a lot of money. While this may be the result of spending for growth, it makes debt much riskier.

Our point of view

To be frank, NKT’s interest coverage and history of converting EBIT to free cash flow makes us rather uncomfortable with its level of leverage. But on the bright side, its net debt to EBITDA is a good sign and makes us more optimistic. Once we consider all of the above factors together, it seems to us that NKT’s debt makes it a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Be aware that NKT displays 1 warning sign in our investment analysis you should know…

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

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.

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