These 4 Measures Indicate That Laboratorios Farmaceuticos Rovi (BME:ROVI) Is Using Debt Safely

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Laboratorios Farmaceuticos Rovi, S.A. (BME:ROVI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Laboratorios Farmaceuticos Rovi

What Is Laboratorios Farmaceuticos Rovi's Debt?

The chart below, which you can click on for greater detail, shows that Laboratorios Farmaceuticos Rovi had €55.6m in debt in June 2022; about the same as the year before. However, it does have €158.9m in cash offsetting this, leading to net cash of €103.4m.

How Healthy Is Laboratorios Farmaceuticos Rovi's Balance Sheet?

The latest balance sheet data shows that Laboratorios Farmaceuticos Rovi had liabilities of €320.6m due within a year, and liabilities of €70.6m falling due after that. On the other hand, it had cash of €158.9m and €138.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €93.4m.

Since publicly traded Laboratorios Farmaceuticos Rovi shares are worth a total of €2.29b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 114% 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 ultimately the future profitability of the business will decide if Laboratorios Farmaceuticos Rovi can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 64% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Laboratorios Farmaceuticos Rovi has €103.4m in net cash. And it impressed us with its EBIT growth of 114% over the last year. So is Laboratorios Farmaceuticos Rovi's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Laboratorios Farmaceuticos Rovi's earnings per share history for free.

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.