Does SkiStar (STO: SKIS B) have a healthy track record?
Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We notice that SkiStar AB (released) (STO: SKIS B) has debt on its balance sheet. But does this debt worry shareholders?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. 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 step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest review for SkiStar
What is SkiStar’s net debt?
As you can see below, at the end of May 2021, SkiStar was in debt of SEK 2.26 billion, up from SEK 1.81 billion a year ago. Click on the image for more details. On the other hand, he has 67.5 million kr in cash, resulting in net debt of around 2.19 billion kr.
A look at the responsibilities of SkiStar
The latest balance sheet data shows SkiStar owed KKR 1.20 billion in debt due within one year, and KKR 2.54 billion in debt due after that. On the other hand, he had cash of kr 67.5 million and kr 188.4 million of receivables due within one year. It therefore has liabilities totaling 3.49 billion crowns more than its combined cash and short-term receivables.
SkiStar has a market cap of 11.6 billion crowns, so it could most likely raise funds to improve its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
We use two main ratios to tell us about leverage versus earnings levels. 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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
SkiStar’s debt is 3.3 times its EBITDA, and its EBIT covers its interest expense 5.4 times. This suggests that while debt levels are significant, we would stop calling them problematic. Unfortunately, SkiStar’s EBIT has fallen 17% in the past four quarters. If incomes continue to drop at this rate, it will be more difficult to manage debt than taking three kids under 5 to a fancy pants restaurant. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the future profitability of the business will decide whether SkiStar can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a company cannot pay its debts with paper profits; he needs hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, SkiStar’s free cash flow has stood at 27% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.
Our point of view
We would go so far as to say that SkiStar’s EBIT growth rate was disappointing. That said, its ability to cover its interest costs with its EBIT is not that much of a concern. Once we consider all of the above factors together it seems like SkiStar’s debt makes it a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. To do this, you need to know the 3 warning signs we spotted with SkiStar.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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