Orkla (OB: ORK) seems to be using debt quite wisely
Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We note that Orkla ASA (OB: ORK) has a debt on its balance sheet. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
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What is Orkla’s debt?
You can click on the graph below for historical figures, but it shows that as of June 2021 Orkla had a debt of 13.6 billion kr, an increase from 9.44 billion kr, on a year. On the other hand, he has 865.0 million kr in cash, resulting in net debt of around 12.8 billion kr.
A look at Orkla’s responsibilities
The latest balance sheet data shows that Orkla had liabilities of KKr 15.0 billion due within one year, and KKr 16.0 billion liabilities due thereafter. On the other hand, he had cash of kr 865.0 million and kr 7.86 billion of receivables due within one year. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by SEK 22.3 billion.
While that may sound like a lot, it isn’t that big of a deal as Orkla has a market cap of Kroner 77.8 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at your ability to repay your debt.
We measure a company’s debt load relative to its earning capacity 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 costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
We would say that Orkla’s moderate net debt to EBITDA ratio (being 1.8) indicates debt prudence. And its impressive EBIT of 38.6 times its interest costs, means the debt load is as light as a peacock feather. We have seen Orkla increase its EBIT by 7.5% over the past twelve months. While this hardly strikes us, it is a bright spot when it comes to debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Orkla 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, while the IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years Orkla has recorded free cash flow of 66% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Orkla’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news does not end there, since its conversion of EBIT into free cash flow also confirms this impression! All these things considered, it looks like Orkla can comfortably manage their current debt levels. Of course, while this leverage can improve returns on equity, it brings more risk, so it’s worth keeping an eye out for. We would be motivated to seek more stock if we found out that Orkla insiders have recently bought stocks. If you too are in luck, because today we are sharing our list of reported insider trades for free.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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