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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Implanet S.A. (EPA:ALIMP) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Implanet's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Implanet had debt of €4.04m, up from €3.39m in one year. However, because it has a cash reserve of €750.0k, its net debt is less, at about €3.29m.
How Strong Is Implanet's Balance Sheet?
According to the last reported balance sheet, Implanet had liabilities of €4.80m due within 12 months, and liabilities of €2.88m due beyond 12 months. Offsetting these obligations, it had cash of €750.0k as well as receivables valued at €1.64m due within 12 months. So its liabilities total €5.29m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of €7.67m, so it does suggest shareholders should keep an eye on Implanet's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Implanet will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Implanet had a loss before interest and tax, and actually shrunk its revenue by 19%, to €6.0m. We would much prefer see growth.
While Implanet's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping €3.2m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through €3.3m of cash over the last year. So suffice it to say we consider the stock very risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Implanet (of which 3 are significant!) 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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