Legendary fund manager Li Lu (whom Charlie Munger supported) once said, âThe 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. We can see that Balticon SA (WSE: BLT) uses debt in his business. But does this debt worry shareholders?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. 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. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest analysis for Balticon
What is Balticon’s debt?
The image below, which you can click for more details, shows Balticon owed Z11.7million at the end of June 2021, a reduction of Z18.0million over one year. On the other hand, he has a cash position of Z2.52million, resulting in a net debt of about Z9.17million.
A look at Balticon’s responsibilities
Zooming in on the latest balance sheet data, we can see that Balticon had z25.5million liabilities due within 12 months and z21.5million liabilities due beyond. In compensation for these obligations, he had cash of 2.52 Mz as well as receivables valued at 27.0 M maturing within 12 months. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by Z 17.5 million.
This deficit is not that big as Balticon is worth Z 56.5million, and so could probably raise enough capital to consolidate its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
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). Thus, we consider debt versus earnings with and without amortization charges.
Balticon’s net debt is only 0.48 times its EBITDA. And its EBIT easily covers its interest costs, which is 17.1 times the size. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Even more impressive was the fact that Balticon increased its EBIT by 106% year over year. If sustained, this growth will make debt even more manageable in the years to come. The balance sheet is clearly the area you need to focus on when analyzing debt. But you can’t look at debt in isolation; since Balticon will need income to pay off this debt. So if you want to know more about its profits, it might be worth checking out this long term profit trend chart.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Balticon has recorded free cash flow totaling 81% of its EBIT, which is higher than we normally expect. This positions it well to repay debt if it is desirable.
Our point of view
Balticon’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news does not end there, since its conversion of EBIT into free cash flow also confirms this impression! Overall, we don’t think Balticon is taking bad risks, as its debt load looks modest. The balance sheet therefore seems rather healthy to us. 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 off the balance sheet. For example, we discovered 2 warning signs for Balticon which you should know before investing here.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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 shares 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 material. Simply Wall St has no position in the mentioned stocks.
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