Laboratorios Farmaceuticos Rovi (BME:ROVI) Seems To Use Debt Rather Sparingly

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.' 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 can see that Laboratorios Farmaceuticos Rovi, S.A. (BME:ROVI) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Laboratorios Farmaceuticos Rovi

What Is Laboratorios Farmaceuticos Rovi's Debt?

As you can see below, Laboratorios Farmaceuticos Rovi had €55.5m of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have €101.7m in cash offsetting this, leading to net cash of €46.2m.

How Strong Is Laboratorios Farmaceuticos Rovi's Balance Sheet?

The latest balance sheet data shows that Laboratorios Farmaceuticos Rovi had liabilities of €248.7m due within a year, and liabilities of €70.5m falling due after that. Offsetting this, it had €101.7m in cash and €169.5m in receivables that were due within 12 months. So its liabilities total €47.9m more than the combination of its cash and short-term receivables.

Having regard to Laboratorios Farmaceuticos Rovi's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the €2.98b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Laboratorios Farmaceuticos Rovi also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Laboratorios Farmaceuticos Rovi grew its EBIT by 140% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Laboratorios Farmaceuticos Rovi's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Laboratorios Farmaceuticos Rovi 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 three years, Laboratorios Farmaceuticos Rovi produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

We could understand if investors are concerned about Laboratorios Farmaceuticos Rovi's liabilities, but we can be reassured by the fact it has has net cash of €46.2m. And we liked the look of last year's 140% year-on-year EBIT growth. So is Laboratorios Farmaceuticos Rovi's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 1 warning sign for Laboratorios Farmaceuticos Rovi that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.