The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Laboratorio Reig Jofre, S.A. (BME:RJF) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses 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 and debt together.
What Is Laboratorio Reig Jofre's Debt?
As you can see below, Laboratorio Reig Jofre had €11.6m of debt at June 2019, down from €24.6m a year prior. But it also has €34.0m in cash to offset that, meaning it has €22.4m net cash.
How Strong Is Laboratorio Reig Jofre's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Laboratorio Reig Jofre had liabilities of €46.6m due within 12 months and liabilities of €42.1m due beyond that. Offsetting this, it had €34.0m in cash and €38.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €16.2m.
Given Laboratorio Reig Jofre has a market capitalization of €178.8m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Laboratorio Reig Jofre also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the other side of the story is that Laboratorio Reig Jofre saw its EBIT decline by 2.3% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Laboratorio Reig Jofre's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Laboratorio Reig Jofre has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Laboratorio Reig Jofre burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Laboratorio Reig Jofre has €22m in net cash. So we are not troubled with Laboratorio Reig Jofre's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Laboratorio Reig Jofre, you may well want to click here to check an interactive graph of its earnings per share history.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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