Rovio Entertainment Oyj (HEL:ROVIO) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Rovio Entertainment Oyj (HEL:ROVIO) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Rovio Entertainment Oyj

What Is Rovio Entertainment Oyj's Debt?

You can click the graphic below for the historical numbers, but it shows that Rovio Entertainment Oyj had €2.00m of debt in March 2021, down from €3.20m, one year before. However, its balance sheet shows it holds €142.8m in cash, so it actually has €140.8m net cash.

How Healthy Is Rovio Entertainment Oyj's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Rovio Entertainment Oyj had liabilities of €36.5m due within 12 months and liabilities of €5.40m due beyond that. Offsetting this, it had €142.8m in cash and €27.8m in receivables that were due within 12 months. So it can boast €128.7m more liquid assets than total liabilities.

This excess liquidity suggests that Rovio Entertainment Oyj is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Rovio Entertainment Oyj boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Rovio Entertainment Oyj grew its EBIT by 89% over the last twelve months, and that growth will make it easier to handle its debt. 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 Rovio Entertainment Oyj 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Rovio Entertainment Oyj 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. Over the last three years, Rovio Entertainment Oyj actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Rovio Entertainment Oyj has net cash of €140.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in €51m. The bottom line is that we do not find Rovio Entertainment Oyj's debt levels at all concerning. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Rovio Entertainment Oyj is showing 1 warning sign in our investment analysis , you should know about...

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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