Here’s why the Atrium Ljungberg (STO: ATRLJ B) has a heavy debt burden

Legendary fund manager Li Lu (whom 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.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We notice that Atrium Ljungberg AB (pub) (STO: ATRLJ B) has debt on its balance sheet. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first step in examining a business’s debt levels is to consider its cash flow and debt together.

Check out our latest analysis for Atrium Ljungberg

What is Atrium Ljungberg’s debt?

The image below, which you can click for more details, shows that in September 2021 Atrium Ljungberg was in debt of Kroner 20.6 billion, compared to Kroner 19.3 billion in a year. However, it has 801.0 million kr in cash offsetting this, which leads to a net debt of around 19.8 billion kr.

OM: ATRLJ B History of debt to equity December 19, 2021

How strong is Atrium Ljungberg’s balance sheet?

According to the latest published balance sheet, Atrium Ljungberg had liabilities of SEK 972.0 million due within 12 months and liabilities of SEK 27.1 billion due beyond 12 months. In compensation for these obligations, he had cash of Kroner 801.0 million as well as receivables valued at Kroner 411.0 million within 12 months. Its liabilities therefore total SEK 26.8 billion more than the combination of its cash and short-term receivables.

When you consider that this shortfall exceeds the market cap of the company kr24.5b, you may well be inclined to carefully review the balance sheet. In the event that the company were to clean up its balance sheet quickly, it seems likely that shareholders would suffer significant dilution.

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 earnings 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.

Strangely, Atrium Ljungberg has a very high EBITDA ratio of 13.1 which implies high debt but strong interest coverage of 1k. So either he has access to very cheap long-term debt or his interest charges will go up! Notably, Atrium Ljungberg’s EBIT has been fairly stable over the past year. We would rather see some growth in earnings as it always helps reduce debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Atrium Ljungberg’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Over the past three years Atrium Ljungberg has recorded free cash flow totaling 81% of its EBIT, which is higher than what we normally expect. This positions it well to repay debt if it is desirable.

Our point of view

We feel some apprehension about Atrium Ljungberg’s net debt versus EBITDA, but we also have some bright spots to focus on. Both its interest coverage and the conversion of EBIT to free cash flow were encouraging signs. We think Atrium Ljungberg’s debt makes it a bit risky, after looking at the aforementioned data points together. Not all risks are bad, as they can increase stock returns if they are profitable, but this risk of leverage is worth keeping in mind. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. We have identified 3 warning signs with Atrium Ljungberg (at least 2 which are not too suitable for us), and understanding them should be part of your investment process.

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.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock 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 any of the stocks mentioned.

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John A. Bogar