Is the Dometic Group (STO:DOM) using too much debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Dometic Group AB (publisher) (STO:DOM) is in debt. But does this debt worry shareholders?

Why is debt risky?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. 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. By replacing dilution, however, debt can be a great 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 has is to look at its cash and debt together.

Discover our latest analysis for Dometic Group

What is the debt of the Dometic group?

The image below, which you can click on for more details, shows that in March 2022, the Dometic Group had a debt of 16.3 billion kr, compared to 12.8 billion kr in one year. However, he has 3.14 billion kr in cash to offset this, resulting in a net debt of around 13.2 billion kr.

OM:DOM Debt to Equity Historical June 19, 2022

A look at the liabilities of the Dometic group

Zooming in on the latest balance sheet data, we can see that the Dometic Group had liabilities of 7.05 billion kr due within 12 months and liabilities of 24.1 billion kr due beyond. In return, he had 3.14 billion kr in cash and 4.58 billion kr in debt due within 12 months. Thus, its liabilities total 23.4 billion kr more than the combination of its cash and short-term receivables.

When you consider that this shortfall exceeds the market capitalization of the company, you might be inclined to take a close look at the balance sheet. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.

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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 3.4, the Dometic Group has quite a significant amount of debt. On the positive side, its EBIT was 7.5 times its interest expense, and its net debt to EBITDA ratio was quite high, at 3.4. Importantly, the Dometic Group has increased its EBIT by 46% over the last twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine the Dometic Group’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 needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, the Dometic Group has recorded free cash flow of 72% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

The Dometic Group’s EBIT growth rate was a real benefit in this analysis, as was its conversion of EBIT to free cash flow. On the other hand, our confidence has been shaken by his apparent struggle to manage his total liabilities. Considering all the factors mentioned above, we feel a bit cautious about the Dometic Group’s use of debt. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we found 3 warning signs for Dometic Group (1 doesn’t suit us too much!) which you should be aware of before investing here.

If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this 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 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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