Is Akzo Nobel (AMS: AKZA) a risky investment?
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.” 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. Like many other companies Akzo Nobel AG (AMS: AKZA) uses debt. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company can’t meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest review for Akzo Nobel
How much debt does Akzo Nobel have?
The image below, which you can click for more details, shows that in September 2021 Akzo Nobel had a debt of 3.08 billion euros, compared to 2.93 billion euros in a year. However, he also had 1.10 billion euros in cash, so his net debt is 1.98 billion euros.
How strong is Akzo Nobel’s balance sheet?
According to the last published balance sheet, Akzo Nobel had liabilities of 4.41 billion euros due in 12 months and liabilities of 3.33 billion euros due beyond 12 months. In compensation for these commitments, he had cash of â¬ 1.10 billion as well as receivables valued at â¬ 2.38 billion within 12 months. Its liabilities therefore amount to â¬ 4.25 billion more than the combination of its cash and short-term receivables.
This deficit is not that big as Akzo Nobel is worth 17.5 billion euros and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Akzo Nobel has a low net debt to EBITDA ratio of just 1.4. And its EBIT covers its interest costs a whopping 19.8 times. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Another good sign is that Akzo Nobel was able to increase its EBIT by 28% in twelve months, making it easier to repay the debt. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, the company’s future profitability will decide whether Akzo Nobel can strengthen its balance sheet over time. 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. 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, Akzo Nobel has generated strong free cash flow equivalent to 56% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
The good news is that Akzo Nobel’s demonstrated ability to cover his interest costs with his EBIT delights us like a fluffy puppy does a toddler. And the good news doesn’t end there, because its EBIT growth rate also supports this impression! Looking at the big picture, we think Akzo Nobel’s use of debt looks very reasonable and we don’t care. After all, reasonable leverage can increase returns on equity. There is no doubt that we learn the most about debt from the balance sheet. 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 Akzo Nobel that you need to be aware of.
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-flow net-growth stocks.
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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.