Pandora (CPH:PNDORA) appears to be using debt sparingly

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Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies Pandora A/S (CPH:PNDORA) uses debt. But does this debt worry shareholders?

When is debt a problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.

See our latest analysis for Pandora

What is Pandora’s debt?

The image below, which you can click on for more details, shows that in March 2022, Pandora had a debt of 5.20 billion kr, compared to 2.98 billion kr in one year. However, as it has a cash reserve of 716.0 million kr, its net debt is lower at around 4.48 billion kr.

CPSE: PNDORA Debt to Equity History June 25, 2022

How strong is Pandora’s balance sheet?

The latest balance sheet data shows that Pandora had liabilities of 6.71 billion kr maturing within one year, and liabilities of 7.18 billion kr maturing thereafter. As compensation for these obligations, it had liquid assets of 716.0 million kr as well as receivables valued at 1.88 billion kr and payable within 12 months. Thus, its liabilities total kr 11.3 billion more than the combination of its cash and short-term receivables.

While that might sound like a lot, it’s not that bad since Pandora has a market capitalization of 43.8 billion kr, so it could probably strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at its ability to repay debt.

We measure a company’s leverage against its earning power 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 charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Pandora has a low net debt to EBITDA ratio of just 0.65. And its EBIT easily covers its interest charges, being 205 times greater. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, we are happy to report that Pandora has increased its EBIT by 57%, reducing the specter of future debt repayments. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Pandora’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Pandora has generated free cash flow of a very strong 99% of EBIT, more than we expected. This positions him well to pay off debt if desired.

Our point of view

Fortunately, Pandora’s impressive interest coverage means it has the upper hand on its debt. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Overall, we don’t think Pandora is taking bad risks, as its leverage looks modest. So we are not worried about using a little leverage on the balance sheet. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example – Pandora has 3 warning signs we think you should know.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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