Is Kemira Oyj (HEL: KEMIRA) Using Too Much Debt?
Legendary fund manager Li Lu (whom Charlie Munger supported) once said, âThe biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We note that Kemira Oyj (HEL: KEMIRA) has debt on her balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt entail?
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. If things really go wrong, lenders can take over the business. 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. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
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What is Kemira Oyj’s net debt?
As you can see below, Kemira Oyj had a debt of 848.6 million euros, as of June 2021, roughly the same as the year before. You can click on the graph for more details. However, because it has a cash reserve of â¬ 145.3 million, its net debt is lower, at around â¬ 703.3 million.
How healthy is Kemira Oyj’s track record?
According to the latest published balance sheet, Kemira Oyj had liabilities of â¬ 718.0 million less than 12 months and liabilities of â¬ 969.3 million more than 12 months. On the other hand, it had cash of â¬ 145.3 million and â¬ 427.7 million in receivables within one year. It therefore has liabilities totaling 1.11 billion euros more than its combined cash and short-term receivables.
While that might sound like a lot, it’s not that bad since Kemira Oyj has a market cap of 2.09 billion euros, and could therefore likely strengthen her balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With a debt to EBITDA ratio of 1.9, Kemira Oyj uses debt smartly but responsibly. And the attractive interest coverage (EBIT of 7.6 times the interest costs) certainly does not do everything to dispel this impression. Unfortunately, Kemira Oyj has seen her EBIT drop 6.1% over the past twelve months. If incomes continue to decline, managing that debt will be difficult, like delivering hot soup on a unicycle. The balance sheet is clearly the area you need to focus on when analyzing debt. But it’s future earnings, more than anything, that will determine Kemira Oyj’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Kemira Oyj has generated strong free cash flow equivalent to 71% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
When it comes to the balance sheet, the bright spot for Kemira Oyj was the fact that he seems able to convert EBIT to free cash flow with confidence. But the other factors we noted above weren’t so encouraging. For example, it looks like he has to struggle a bit to increase his EBIT. When we consider all of the factors mentioned above, we feel a little cautious about Kemira Oyj’s use of debt. While we understand that debt can improve returns on equity, we suggest shareholders watch their debt level closely, lest they increase. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. We have identified 1 warning sign with Kemira Oyj, and understanding them should be part of your investment process.
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.
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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