Here's Why Regenbogen (FRA:RGB) Can Afford Some Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Regenbogen AG (FRA:RGB) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Regenbogen

How Much Debt Does Regenbogen Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Regenbogen had €9.79m of debt, an increase on €9.39m, over one year. However, because it has a cash reserve of €6.68m, its net debt is less, at about €3.11m.

How Healthy Is Regenbogen's Balance Sheet?

The latest balance sheet data shows that Regenbogen had liabilities of €875.0k due within a year, and liabilities of €21.6m falling due after that. Offsetting these obligations, it had cash of €6.68m as well as receivables valued at €5.10m due within 12 months. So its liabilities total €10.7m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of €15.2m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is Regenbogen's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Regenbogen had a loss before interest and tax, and actually shrunk its revenue by 3.1%, to €15m. We would much prefer see growth.

Caveat Emptor

Importantly, Regenbogen had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at €673k. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of €7.6m and the profit of €2.6m. So one might argue that there's still a chance it can get things on the right track. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Regenbogen you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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