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. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Pierrel S.p.A. (BIT:PRL) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Pierrel
How Much Debt Does Pierrel Carry?
The chart below, which you can click on for greater detail, shows that Pierrel had €12.5m in debt in June 2019; about the same as the year before. However, it also had €8.02m in cash, and so its net debt is €4.52m.
How Healthy Is Pierrel's Balance Sheet?
The latest balance sheet data shows that Pierrel had liabilities of €9.02m due within a year, and liabilities of €12.0m falling due after that. Offsetting these obligations, it had cash of €8.02m as well as receivables valued at €2.12m due within 12 months. So it has liabilities totalling €10.8m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Pierrel has a market capitalization of €40.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).