Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Lanakam S.A. (ATH:LANAC) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Lanakam Carry?
As you can see below, at the end of December 2020, Lanakam had €1.52m of debt, up from €1.01m a year ago. Click the image for more detail. However, because it has a cash reserve of €121.7k, its net debt is less, at about €1.40m.
A Look At Lanakam's Liabilities
We can see from the most recent balance sheet that Lanakam had liabilities of €2.48m falling due within a year, and liabilities of €1.99m due beyond that. On the other hand, it had cash of €121.7k and €561.5k worth of receivables due within a year. So it has liabilities totalling €3.79m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of €5.46m. 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 Lanakam 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.
Over 12 months, Lanakam made a loss at the EBIT level, and saw its revenue drop to €1.4m, which is a fall of 19%. We would much prefer see growth.
While Lanakam's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at €492k. 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 €567k of cash over the last year. So suffice it to say we consider the stock very 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. For example Lanakam has 5 warning signs (and 3 which shouldn't be ignored) we think 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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