Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. It’s 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 can see that Kingspan plc group (ISE: KRX) uses debt in his business. But should shareholders be concerned about its use of debt?
When Is Debt a Problem?
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. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing 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. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
What is the debt of the Kingspan group?
You can click on the graph below for historical figures, but it shows that as of December 2020, Kingspan Group had 1.58 billion euros in debt, an increase from 848.8 million euros, over a year. On the other hand, it has 1.33 billion euros in cash, leading to a net debt of around 253.0 million euros.
A look at the liabilities of the Kingspan group
According to the latest published balance sheet, Kingspan Group had liabilities of € 1.20 billion within 12 months and liabilities of € 1.74 billion due beyond 12 months. In return, he had € 1.33 billion in cash and € 767.4 million in receivables due within 12 months. Its liabilities therefore amount to € 846.3 million more than the combination of its cash and short-term receivables.
Of course, Kingspan Group has a titanic market cap of 12.8 billion euros, so those liabilities are probably manageable. Having said that, it is clear that we must continue to monitor his record lest it get worse.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Kingspan Group has a low net debt to EBITDA ratio of just 0.42. And its EBIT covers its interest costs a whopping 21.3 times. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. The good news is that Kingspan Group increased its EBIT by 2.7% year over year, which should allay concerns about debt repayment. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Kingspan Group’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, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Kingspan Group has recorded free cash flow totaling 83% of its EBIT, which is higher than what we normally expected. This puts him in a very strong position to pay off the debt.
Our point of view
Fortunately, the Kingspan Group’s impressive interest coverage means it has the upper hand on its debt. And the good news does not end there, since its conversion of EBIT into free cash flow also confirms this impression! When zoomed out, Kingspan Group appears to be using debt quite sensibly; and that gets the nod from us. After all, reasonable leverage can increase returns on equity. 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. For example, we have identified 1 warning sign for the Kingspan group that you need to be aware of.
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.
If you are looking to trade the Kingspan Group, open an account with the cheapest * professional approved platform, Interactive brokers. Their clients from more than 200 countries and territories trade stocks, options, futures, currencies, bonds and funds around the world from a single integrated account. Promoted
This Simply Wall St article is general in nature. 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 the mentioned stocks.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Online Annual Review 2020
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.