These 4 metrics indicate that Ambu (CPH:AMBU B) is using debt a lot

David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Ambu A/S (CPH:AMBU B) uses debt in its business. But should shareholders worry about its use of debt?

When is debt a problem?

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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

See our latest review for Ambu

What is Ambu’s debt?

The image below, which you can click on for more details, shows that in March 2022, Ambu had a debt of 985.0 million kr, compared to 406.0 million kr in one year. However, since it has a cash reserve of 112.0 million kr, its net debt is less at around 873.0 million kr.

A Look at Ambu’s Responsibilities

According to the latest published balance sheet, Ambu had liabilities of kr 864.0 million maturing within 12 months and liabilities of kr 1.53 billion maturing beyond 12 months. As compensation for these obligations, it had liquid assets of 112.0 million kr as well as receivables valued at 739.0 million kr and payable within 12 months. Thus, its liabilities total kr 1.54 billion more than the combination of its cash and short-term receivables.

Given that Ambu has a market capitalization of 22.0 billion kr, it is hard to believe that these liabilities pose a threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (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 ).

Ambu has a net debt to EBITDA ratio of 2.7, suggesting it uses good leverage to increase returns. But the high interest coverage of 8.1 suggests it can easily repay that debt. Shareholders should know that Ambu’s EBIT fell 58% last year. If this decline continues, it will be more difficult to repay debts than to sell foie gras at a vegan convention. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Ambu can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a company can only repay its debts with cold hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Ambu has burned a lot of money. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.

Our point of view

At first glance, Ambu’s conversion from EBIT to free cash flow left us hesitant about the stock, and its EBIT growth rate was no more attractive than the single empty restaurant overnight. the busiest of the year. But on the bright side, its interest coverage is a good sign and makes us more optimistic. It should also be noted that Ambu is in the medical equipment industry, which is often seen as quite defensive. Looking at the balance sheet and taking all of these factors into account, we think the debt makes Ambu stock a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on less debt. 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. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Ambu you should know.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.

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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.