We Think Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt (BUSE:RICHTER) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt. (BUSE:RICHTER) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt

How Much Debt Does Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt had Ft67.0b of debt, an increase on Ft4.78b, over one year. However, it also had Ft61.1b in cash, and so its net debt is Ft5.91b.

A Look At Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's Liabilities

According to the last reported balance sheet, Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt had liabilities of Ft123.2b due within 12 months, and liabilities of Ft99.0b due beyond 12 months. On the other hand, it had cash of Ft61.1b and Ft205.4b worth of receivables due within a year. So it can boast Ft44.2b 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. But either way, Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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).

Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt has barely any net debt, as demonstrated by its net debt to EBITDA ratio of only 0.034. Happily, it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like an Olympic ice-skater handles a pirouette. The good news is that Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt has increased its EBIT by 9.4% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. When we consider the range of factors above, it looks like Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. Over time, share prices tend to follow earnings per share, so if you're interested in Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt, you may well want to click here to check an interactive graph of its earnings per share history.

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.