We Think Componenta (HEL:CTH1V) Can Stay On Top Of Its 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 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 Componenta Corporation (HEL:CTH1V) does use debt in its business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Componenta

What Is Componenta's Debt?

As you can see below, at the end of June 2023, Componenta had €4.40m of debt, up from €2.15m a year ago. Click the image for more detail. However, its balance sheet shows it holds €13.0m in cash, so it actually has €8.56m net cash.

A Look At Componenta's Liabilities

The latest balance sheet data shows that Componenta had liabilities of €24.3m due within a year, and liabilities of €12.3m falling due after that. On the other hand, it had cash of €13.0m and €4.63m worth of receivables due within a year. So its liabilities total €19.0m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of €22.7m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Componenta boasts net cash, so it's fair to say it does not have a heavy debt load!

Pleasingly, Componenta is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 327% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Componenta can strengthen its balance sheet over time. 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. While Componenta 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. Happily for any shareholders, Componenta actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Componenta's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €8.56m. The cherry on top was that in converted 162% of that EBIT to free cash flow, bringing in €6.6m. So we don't have any problem with Componenta's use of debt. 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 2 warning signs for Componenta 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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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.