We think Kemira Oyj (HEL:KEMIRA) can stay on top of its debt
Some say volatility, rather than debt, is the best way to think about risk as an investor, but 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. We notice that Kemira Oyj (HEL:KEMIRA) has debt on its balance sheet. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Kemira Oyj
What is Kemira Oyj’s net debt?
As you can see below, Kemira Oyj had €853.2 million in debt, as of September 2021, which is about the same as the previous year. You can click on the graph for more details. However, because it has a cash reserve of €184.4 million, its net debt is lower, at around €668.8 million.
A look at the responsibilities of Kemira Oyj
We can see from the most recent balance sheet that Kemira Oyj had liabilities of €770.2m due in one year and liabilities of €985.2m due beyond. On the other hand, it had €184.4 million in cash and €452.2 million in receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €1.12 billion.
Kemira Oyj has a market capitalization of €1.97 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
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). 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 ).
Kemira Oyj’s net debt of 1.9x EBITDA suggests judicious use of debt. And the fact that its trailing twelve months EBIT was 7.4 times its interest expense aligns with that theme. Unfortunately, Kemira Oyj has seen its EBIT fall by 2.6% over the last twelve months. If earnings continue to fall, managing that debt will be as difficult as delivering hot soup on a unicycle. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Kemira Oyj’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Kemira Oyj has recorded free cash flow of 73% of its EBIT, which is about normal given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
According to our analysis, Kemira Oyj’s EBIT to free cash flow conversion should signal that it will not have too many problems with its debt. But the other factors we noted above weren’t so encouraging. For example, his level of total liabilities makes us a little nervous about his debt. Looking at all this data, we feel a bit cautious about Kemira Oyj’s debt levels. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that Kemira Oyj shows 1 warning sign in our investment analysis , you should know…
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.