Is Green Landscaping Group (STO:GREEN) A Risky Investment?
Legendary fund manager Li Lu (who backed Charlie Munger) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Green Landscaping Group AB (publ) (STO:GREEN) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
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What Is Green Landscaping Group’s Debt?
The image below, which you can click on for greater detail, shows that at September 2022 Green Landscaping Group had debt of kr1.52b, up from kr879.9m in one year. However, because it has a cash reserve of kr320.0m, its net debt is less, at about kr1.20b.
OM:GREEN Debt to Equity History December 6th 2022
A Look At Green Landscaping Group’s Liabilities
We can see from the most recent balance sheet that Green Landscaping Group had liabilities of kr1.09b falling due within a year, and liabilities of kr1.93b due beyond that. On the other hand, it had cash of kr320.0m and kr985.0m worth of receivables due within a year. So its liabilities total kr1.71b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Green Landscaping Group has a market capitalization of kr3.56b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it’s clear that we should definitely examine closely whether it can manage its debt without dilution.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense ( its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Green Landscaping Group has net debt to EBITDA of 3.2 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 8.4 times its interest expense, and its net debt to EBITDA, was quite high, at 3.2. Importantly, Green Landscaping Group grew its EBIT by 98% over the last twelve months, and that growth will make it easier to handle its debt. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Green Landscaping Group’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Green Landscaping Group recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
Green Landscaping Group’s conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Taking all this data into account, it seems to us that Green Landscaping Group is taking a pretty sensitive approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We’ve identified 2 warning signs with Green Landscaping Group (at least 1 which makes us a bit uncomfortable), and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% freeright now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.