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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. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Link Prop Investment AB (publ) (STO:LINKAB) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Link Prop Investment
What Is Link Prop Investment's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Link Prop Investment had debt of kr167.3m, up from kr159.8m in one year. However, it does have kr26.3m in cash offsetting this, leading to net debt of about kr141.0m.
A Look At Link Prop Investment's Liabilities
We can see from the most recent balance sheet that Link Prop Investment had liabilities of kr25.4m falling due within a year, and liabilities of kr182.0m due beyond that. Offsetting this, it had kr26.3m in cash and kr13.6k in receivables that were due within 12 months. So its liabilities total kr181.1m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of kr204.3m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With a net debt to EBITDA ratio of 5.8, it's fair to say Link Prop Investment does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 5.9 times, suggesting it can responsibly service its obligations. One way Link Prop Investment could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 15%, as it did over the last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Link Prop Investment's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.