These 4 Measures Indicate That Regenbogen (FRA:RGB) Is Using Debt Reasonably Well

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Regenbogen AG (FRA:RGB) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Regenbogen

What Is Regenbogen's Net Debt?

As you can see below, Regenbogen had €9.38m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has €9.52m in cash to offset that, meaning it has €138.0k net cash.

A Look At Regenbogen's Liabilities

According to the last reported balance sheet, Regenbogen had liabilities of €1.56m due within 12 months, and liabilities of €19.0m due beyond 12 months. On the other hand, it had cash of €9.52m and €2.85m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €8.14m.

This deficit isn't so bad because Regenbogen is worth €19.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Regenbogen also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Regenbogen made a loss at the EBIT level, last year, it was also good to see that it generated €3.5m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Regenbogen's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Regenbogen may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last year, Regenbogen generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While Regenbogen does have more liabilities than liquid assets, it also has net cash of €138.0k. And it impressed us with free cash flow of €3.0m, being 86% of its EBIT. So we are not troubled with Regenbogen's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Regenbogen that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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