Here’s why Lena Lighting (WSE:LEN) can manage her debt responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Mostly, Lena Lighting AG (WSE:LEN) is in debt. But the real question is whether this debt makes the business risky.

When is debt a problem?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Check out our latest analysis for Lena Lighting

What is Lena Lighting’s net debt?

As you can see below, at the end of September 2021, Lena Lighting had a debt of 13.2 million zł, compared to none a year ago. Click on the image for more details. However, since it has a cash reserve of 457.0 kzł, its net debt is lower, at around 12.8 million zł.

WSE:LEN Debt to Equity March 29, 2022

How healthy is Lena Lighting’s balance sheet?

We can see from the most recent balance sheet that Lena Lighting had liabilities of 26.9 million zł due in one year, and liabilities of 2.44 million zł due beyond. On the other hand, he had cash of 457,000 zł and 36.4 million zł of receivables due within the year. He can therefore boast of having 7.44 million zł more cash than total Passives.

This short-term liquidity is a sign that Lena Lighting could probably repay her debt easily, as her balance sheet is far from stretched.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Lena Lighting’s net debt is only 0.62 times its EBITDA. And its EBIT easily covers its interest charges, being 595 times greater. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, we are pleased to report that Lena Lighting increased its EBIT by 74%, reducing the specter of future debt repayments. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Lena Lighting that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Lena Lighting’s free cash flow has been 28% of its EBIT, less than expected. It’s not great when it comes to paying off debt.

Our point of view

Lena Lighting’s interest coverage suggests she can manage her debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But, on a darker note, we are a bit concerned about its conversion of EBIT into free cash flow. Zooming out, Lena Lighting seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 2 warning signs for Lena Lighting of which you should be aware.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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.

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