Does Luka Rijeka d.d (ZGSE:LKRI) Have A Healthy Balance Sheet?

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.' 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 Luka Rijeka d.d. (ZGSE:LKRI) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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 Luka Rijeka d.d

What Is Luka Rijeka d.d's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Luka Rijeka d.d had Kn129.6m of debt, an increase on Kn63.2m, over one year. However, it does have Kn46.0m in cash offsetting this, leading to net debt of about Kn83.6m.

A Look At Luka Rijeka d.d's Liabilities

We can see from the most recent balance sheet that Luka Rijeka d.d had liabilities of Kn203.0m falling due within a year, and liabilities of Kn337.7m due beyond that. Offsetting these obligations, it had cash of Kn46.0m as well as receivables valued at Kn47.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Kn447.8m.

Luka Rijeka d.d has a market capitalization of Kn954.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Even though Luka Rijeka d.d's debt is only 2.4, its interest cover is really very low at 1.3. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. Notably, Luka Rijeka d.d made a loss at the EBIT level, last year, but improved that to positive EBIT of Kn22m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Luka Rijeka d.d'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Luka Rijeka d.d actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Luka Rijeka d.d's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. We would also note that Infrastructure industry companies like Luka Rijeka d.d commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Luka Rijeka d.d's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. To that end, you should be aware of the 2 warning signs we've spotted with Luka Rijeka d.d .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.