Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Erbud SA (WSE:ERB) uses debt. But should shareholders worry about its use of debt?
Why is debt risky?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
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What is Erbud’s debt?
You can click on the graph below for historical figures, but it shows that Erbud had zł162.7 million in debt in September 2021, compared to zł188.7 million a year before. However, he has zł353.9 million of cash to offset this, resulting in a net cash of zł191.1 million.
How healthy is Erbud’s balance sheet?
The latest balance sheet data shows that Erbud had liabilities of zł 970.8 million due within one year, and liabilities of zł 202.1 million falling due thereafter. In compensation for these obligations, it had cash of 353.9 million zł as well as receivables valued at 1.13 billion zł and payable within 12 months. He can therefore boast of having 307.8 million zł more cash than total Passives.
This surplus strongly suggests that Erbud has a rock-solid balance sheet (and debt is absolutely nothing to worry about). With that in mind, one could argue that its track record means the company is capable of dealing with some adversity. In short, Erbud has a clean cash flow, so it’s fair to say that it doesn’t have a lot of debt!
Another good sign, Erbud was able to increase its EBIT by 23% in twelve months, thus facilitating the repayment of its debt. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; because Erbud will need income to repay this debt. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. Erbud may have net cash on the balance sheet, but it’s always interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Over the past three years, Erbud has recorded negative free cash flow, in total. Debt is generally more expensive and almost always riskier in the hands of a company with negative free cash flow. Shareholders should hope for an improvement.
While we sympathize with investors who find debt a concern, you should bear in mind that Erbud has a net cash position of zł 191.1 million, as well as more liquid assets than liabilities. And we liked the look of EBIT growth of 23% YoY last year. We therefore do not believe that Erbud’s use of debt is risky. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. We have identified 2 warning signs with Erbud, and understanding them should be part of your investment process.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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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.