In This Article:
David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Sectra AB (publ) (STO:SECT B) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Sectra
What Is Sectra's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Sectra had kr31.5m of debt in April 2019, down from kr56.6m, one year before. However, its balance sheet shows it holds kr331.9m in cash, so it actually has kr300.5m net cash.
A Look At Sectra's Liabilities
The latest balance sheet data shows that Sectra had liabilities of kr558.7m due within a year, and liabilities of kr28.2m falling due after that. Offsetting these obligations, it had cash of kr331.9m as well as receivables valued at kr507.6m due within 12 months. So it can boast kr252.6m more liquid assets than total liabilities.
This surplus suggests that Sectra has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sectra has more cash than debt is arguably a good indication that it can manage its debt safely.
The good news is that Sectra has increased its EBIT by 9.9% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sectra can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sectra may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Sectra generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.