Is Telefonaktiebolaget LM Ericsson (STO:ERIC B) A Risky Investment?
David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Telefonaktiebolaget LM Ericsson (publ) (STO:ERIC B) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Telefonaktiebolaget LM Ericsson
How Much Debt Does Telefonaktiebolaget LM Ericsson Carry?
The image below, which you can click on for greater detail, shows that at December 2019 Telefonaktiebolaget LM Ericsson had debt of kr37.7b, up from kr33.4b in one year. But it also has kr51.8b in cash to offset that, meaning it has kr14.1b net cash.
How Strong Is Telefonaktiebolaget LM Ericsson's Balance Sheet?
We can see from the most recent balance sheet that Telefonaktiebolaget LM Ericsson had liabilities of kr116.8b falling due within a year, and liabilities of kr77.7b due beyond that. Offsetting these obligations, it had cash of kr51.8b as well as receivables valued at kr71.2b due within 12 months. So its liabilities total kr71.5b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Telefonaktiebolaget LM Ericsson has a huge market capitalization of kr273.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Telefonaktiebolaget LM Ericsson boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, Telefonaktiebolaget LM Ericsson grew its EBIT by 117% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Telefonaktiebolaget LM Ericsson'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 report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Telefonaktiebolaget LM Ericsson may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last two years, Telefonaktiebolaget LM Ericsson's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing up
While Telefonaktiebolaget LM Ericsson does have more liabilities than liquid assets, it also has net cash of kr14.1b. And it impressed us with its EBIT growth of 117% over the last year. So is Telefonaktiebolaget LM Ericsson's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Telefonaktiebolaget LM Ericsson that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
