Is Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt (BUSE:RICHTER) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 can see that Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt. (BUSE:RICHTER) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt

What Is Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt had debt of Ft85.3b, up from Ft10.0b in one year. On the flip side, it has Ft70.1b in cash leading to net debt of about Ft15.2b.

How Healthy Is Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's Balance Sheet?

We can see from the most recent balance sheet that Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt had liabilities of Ft157.8b falling due within a year, and liabilities of Ft110.6b due beyond that. On the other hand, it had cash of Ft70.1b and Ft234.8b worth of receivables due within a year. So it can boast Ft36.5b more liquid assets than total liabilities.

This short term liquidity is a sign that Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt has a very light debt load indeed.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt has very modest net debt levels, with net debt at just 0.077 times EBITDA. Happily, it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt as easily as enthusiastic spray-tanners take on an orange hue. Another good sign is that Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's free cash flow amounted to 33% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Zooming out, Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's earnings per share history for free.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.