Libertas 7 (BDM:LIB) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Libertas 7, S.A. (BDM:LIB) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Libertas 7

How Much Debt Does Libertas 7 Carry?

As you can see below, Libertas 7 had €38.1m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have €49.1m in cash offsetting this, leading to net cash of €11.0m.

A Look At Libertas 7's Liabilities

According to the last reported balance sheet, Libertas 7 had liabilities of €18.9m due within 12 months, and liabilities of €39.6m due beyond 12 months. Offsetting this, it had €49.1m in cash and €1.34m in receivables that were due within 12 months. So its liabilities total €8.14m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Libertas 7 has a market capitalization of €24.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Libertas 7 boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Libertas 7 made a loss at the EBIT level, last year, but improved that to positive EBIT of €896k in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Libertas 7 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. While Libertas 7 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 year, Libertas 7 burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

Although Libertas 7's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €11.0m. Despite its cash we think that Libertas 7 seems to struggle to convert EBIT to free cash flow, so we are wary of the stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Libertas 7 that you should be aware of before investing here.

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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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.