Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Gunnebo AB (publ) (STO:GUNN) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Gunnebo
What Is Gunnebo's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Gunnebo had kr2.00b of debt, an increase on kr1.68b, over one year. However, it does have kr569.0m in cash offsetting this, leading to net debt of about kr1.44b.
A Look At Gunnebo's Liabilities
Zooming in on the latest balance sheet data, we can see that Gunnebo had liabilities of kr1.58b due within 12 months and liabilities of kr2.47b due beyond that. On the other hand, it had cash of kr569.0m and kr955.0m worth of receivables due within a year. So its liabilities total kr2.53b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's kr1.79b market capitalization, you might well be inclined to review the balance sheet, just like one might study a new partner's social media. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.