Does Losinjska Plovidba Holding d.d (ZGSE:LPLH) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Losinjska Plovidba Holding d.d. (ZGSE:LPLH) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Losinjska Plovidba Holding d.d

How Much Debt Does Losinjska Plovidba Holding d.d Carry?

As you can see below, at the end of September 2020, Losinjska Plovidba Holding d.d had Kn37.6m of debt, up from Kn21.5m a year ago. Click the image for more detail. However, it also had Kn29.7m in cash, and so its net debt is Kn7.83m.

How Strong Is Losinjska Plovidba Holding d.d's Balance Sheet?

We can see from the most recent balance sheet that Losinjska Plovidba Holding d.d had liabilities of Kn19.3m falling due within a year, and liabilities of Kn34.3m due beyond that. Offsetting this, it had Kn29.7m in cash and Kn12.9m in receivables that were due within 12 months. So its liabilities total Kn10.9m more than the combination of its cash and short-term receivables.

Given Losinjska Plovidba Holding d.d has a market capitalization of Kn90.1m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

While Losinjska Plovidba Holding d.d's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.6 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably, Losinjska Plovidba Holding d.d made a loss at the EBIT level, last year, but improved that to positive EBIT of Kn1.0m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Losinjska Plovidba Holding d.d 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Losinjska Plovidba Holding d.d saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Losinjska Plovidba Holding d.d's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its net debt to EBITDA is relatively strong. When we consider all the factors discussed, it seems to us that Losinjska Plovidba Holding d.d is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Case in point: We've spotted 1 warning sign for Losinjska Plovidba Holding d.d 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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