Is Selected Textiles (ATH:EPIL) Using Debt In A Risky Way?

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. Importantly, Selected Textiles S.A. (ATH:EPIL) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for Selected Textiles

How Much Debt Does Selected Textiles Carry?

The chart below, which you can click on for greater detail, shows that Selected Textiles had €66.8m in debt in June 2020; about the same as the year before. On the flip side, it has €2.05m in cash leading to net debt of about €64.7m.

How Strong Is Selected Textiles's Balance Sheet?

The latest balance sheet data shows that Selected Textiles had liabilities of €17.4m due within a year, and liabilities of €71.8m falling due after that. On the other hand, it had cash of €2.05m and €5.23m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €81.9m.

This deficit casts a shadow over the €8.54m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Selected Textiles would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Selected Textiles's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Selected Textiles had a loss before interest and tax, and actually shrunk its revenue by 14%, to €26m. We would much prefer see growth.

Caveat Emptor

Not only did Selected Textiles's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping €1.0m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it lost €2.1m in the last year. So we think buying this stock is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Selected Textiles has 1 warning sign we think 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. 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.
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