Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘volatility is far from synonymous with risk.’ So it seems that the smart money knows that debt – which is usually involved in bankruptcy – is a very important factor, when you evaluate how risky a company is. As with many other companies Pandora A/S (CPH:PNDORA) uses debt. But is this debt a concern for shareholders?
When is debt dangerous?
In general, debt only becomes a real problem when the company cannot easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal obligations to repay the debt, shareholders may walk away with nothing. However, a more common (but still expensive) situation is when a company must dilute shareholders at a cheap share price to get debt under control. By replacing leverage, however, debt can be an extremely good tool for businesses that need capital to invest in growth at higher rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
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What is Pandora’s net debt?
As you can see below, at the end of December 2022, Pandora had kr.4.53b of debt, up from kr.1.32ba a year ago. Click on the image for more details. However, it also had kr.794.0m cash, and so its net debt is kr.3.73b.
How strong is Pandora’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Pandora has liabilities of kr.11.2b within 12 months and liabilities of kr.3.67b beyond that. Offsetting this, it had kr.794.0m of cash and kr.2.44b of receivables due within 12 months. So its cash and near-term receivables, combined total kr.11.6b more liabilities.
Pandora has a market capitalization of kr.55.2b, so it can raise cash to improve its balance sheet if needed. However, it is still worthwhile to take a closer look at your ability to repay the loan.
To size a company’s debt relative to its earnings, we calculate earnings before interest, taxes, depreciation, and amortization (EBITDA) and earnings before interest and taxes (EBIT) divided by its interest expense (EBIT). its interest cover). The advantage of this approach is that we take into account both the total amount of debt (including net debt to EBITDA) and the actual interest expense associated with that debt (along with its interest coverage ratio).
Pandora’s net debt is just 0.49 times its EBITDA. And its EBIT easily covers its interest expenses, 26.4 times the size. So we’re pretty relaxed about its super-conservative use of debt. And we also warmly note that Pandora grew its EBIT by 17% last year, which made it easier to handle its debt load. The balance sheet is obviously the area when you are doing a debt analysis. But ultimately the future profitability of the business will decide whether Pandora can strengthen its balance sheet over time. So if you want to see what the pros think, you might find this free report on analyst profit forecasts interesting.
Finally, a business needs free cash flow to pay off debt; Accounting profit just doesn’t cut it. So it’s worth checking how much of EBIT is supported by free cash flow. Over the past three years, Pandora recorded free cash flow worth a full 88% of its EBIT, which is stronger than we would normally expect. This position is good for paying off debt if it is desirable to do so.
The good news is that Pandora’s ability to demonstrate that it covers its interest expenses through its EBIT makes us as happy as a fluffy dog is a child. And the good news doesn’t stop there, as its EBIT to Free Cash Flow conversion also supports that impression! Looking at the big picture, we think Pandora’s use of debt seems very reasonable and we’re not worried about it. After all, sensible leverage can increase returns on equity. When analyzing debt levels, the balance sheet is an obvious place to start. However, not all investment risk stays within the balance sheet – far from it. Be aware that you are showing Pandora 2 warning signs in our investment analysis You should know…
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then don’t hesitate to explore our exclusive list of pure cash growth stocks today.
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This article by Simply Wall St. is general in nature. We only provide commentary using an unbiased methodology based on historical data and analyst forecasts 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 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 content. Simply Wall St. has no position in any of the stocks mentioned.