Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We notice that KONE Oyj (HEL: KNEBV) has debt on its balance sheet. But the most important question is: what risk does this debt create?
When is debt dangerous?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for KONE Oyj
What is KONE Oyj’s debt?
The graph below, which you can click for more details, shows that KONE Oyj had € 169.8 million in debt as of March 2021; about the same as the year before. However, his balance sheet shows that he holds € 2.02 billion in cash, so he actually has € 1.85 billion in net cash.
A look at the responsibilities of KONE Oyj
The latest balance sheet data shows that KONE Oyj had debts of 5.29 billion euros due within one year, and debts of 639.3 million euros due thereafter. On the other hand, it had cash of € 2.02 billion and € 2.23 billion in receivables within one year. It therefore has total liabilities of 1.67 billion euros more than its combined cash and short-term receivables.
Considering that publicly traded KONE Oyj shares are worth a very impressive total of € 35.8 billion, it seems unlikely that this level of liabilities will be a major threat. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time. Despite her notable liabilities, KONE Oyj has a net cash flow, so it’s fair to say that she doesn’t have a heavy debt load!
The good news is that KONE Oyj increased its EBIT by 6.9% year over year, which should allay concerns about debt repayment. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine KONE 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 can only repay its debts with hard cash, not with book profits. Although KONE Oyj has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it’s building ( or erodes) this cash balance. Over the past three years, KONE Oyj has actually generated more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.
One could understand if investors are worried about the liabilities of KONE Oyj, but one can be reassured by the fact that it has a net cash position of 1.85 billion euros. The icing on the cake is that he converted 103% of that EBIT into free cash flow, bringing in 1.6 billion euros. We therefore do not believe that the use of debt by KONE Oyj is risky. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. Example: we have spotted 1 warning sign for KONE Oyj you must be aware.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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