Here’s why Duroc (STO:DURC B) can manage its debt responsibly

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. 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 Duroc AB (publisher) (STO:DURC B) uses debt. But should shareholders worry about its use of debt?

Why is debt risky?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

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What is Duroc’s debt?

The image below, which you can click on for more details, shows that in June 2022, Duroc had a debt of 291.8 million kr, compared to 199.8 million kr in one year. However, he has 26.1 million kr in cash to offset this, resulting in a net debt of approximately 265.7 million kr.

OM:DURC B Debt to Equity Historical 17 September 2022

How healthy is Duroc’s balance sheet?

We can see from the most recent balance sheet that Duroc had liabilities of 832.7 million kr due within one year, and liabilities of 306.4 million kr due beyond. In return, it had 26.1 million kr in cash and 673.2 million kr in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 439.8 million kr.

While that might sound like a lot, it’s not that bad since Duroc has a market capitalization of 778.1 million kr, so it could probably strengthen its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Duroc’s net debt is only 1.3 times its EBITDA. And its EBIT covers its interest charges 10.1 times. So we’re pretty relaxed about his super-conservative use of debt. Duroc’s EBIT has been fairly stable over the past year, but that shouldn’t be a problem given that it doesn’t have a lot of debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the profits of Duroc that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Duroc has recorded a free cash flow of 42% of its EBIT, which is lower than expected. It’s not great when it comes to paying off debt.

Our point of view

On the balance sheet, the most notable positive for Duroc is the fact that it seems able to cover its interest charges with its EBIT with confidence. However, our other observations were not so encouraging. For example, it looks like he has to struggle a bit to manage his total liabilities. Looking at all this data, we feel a bit cautious about Duroc’s debt levels. While we understand that debt can improve return on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. 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. To do this, you need to find out about the 2 warning signs we spotted some with Duroc (including 1 that makes us a little uncomfortable).

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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