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. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, Midway Holding AB (pub) (STO:MIDW B) is in debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Midway Holding
What is Midway Holding’s debt?
You can click on the graph below for historical figures, but it shows that Midway Holding had a debt of 208.0 million kr in March 2022, compared to 242.0 million kr a year before. On the other hand, he has 46.0 million kr in cash, resulting in a net debt of around 162.0 million kr.
How strong is Midway Holding’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Midway Holding had liabilities of kr 317.2 million due within 12 months and liabilities of kr 530.0 million due beyond. On the other hand, it had a cash position of 46.0 million kr and 160.1 million kr of receivables due within one year. Thus, its liabilities total kr 641.1 million more than the combination of its cash and short-term receivables.
This deficit is considerable compared to its market capitalization of 831.7 million kr, so it suggests that shareholders monitor the use of debt by Midway Holding. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its 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 ).
Midway Holding’s net debt is only 1.2 times its EBITDA. And its EBIT covers its interest charges 25.8 times. So we’re pretty relaxed about his super-conservative use of debt. Even better, Midway Holding increased its EBIT by 545% last year, which is an impressive improvement. This boost will make paying off debt even easier in the future. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Midway Holding 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 taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Midway Holding has experienced substantial negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
We feel some apprehension about Midway Holding’s difficulty in converting EBIT to free cash flow, but we also have positives to focus on. For example, its interest coverage and EBIT growth rate give us some confidence in its ability to manage its debt. From all the angles mentioned above, it seems to us that Midway Holding is a bit risky investment because of its debt. Not all risk is bad, as it can boost stock returns if it pays off, but this leverage risk is worth keeping in mind. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To do this, you need to find out about the 4 warning signs we spotted with Midway Holding (including 1 essential).
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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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.