CIR. - Compagnie Industriali Riunite (BIT:CIR) Takes On Some Risk With Its Use Of Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 note that CIR S.p.A. - Compagnie Industriali Riunite (BIT:CIR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for CIR. - Compagnie Industriali Riunite

How Much Debt Does CIR. - Compagnie Industriali Riunite Carry?

The chart below, which you can click on for greater detail, shows that CIR. - Compagnie Industriali Riunite had €841.9m in debt in December 2020; about the same as the year before. On the flip side, it has €769.0m in cash leading to net debt of about €72.9m.

How Strong Is CIR. - Compagnie Industriali Riunite's Balance Sheet?

According to the last reported balance sheet, CIR. - Compagnie Industriali Riunite had liabilities of €810.9m due within 12 months, and liabilities of €1.67b due beyond 12 months. Offsetting this, it had €769.0m in cash and €274.8m in receivables that were due within 12 months. So it has liabilities totalling €1.44b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €628.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, CIR. - Compagnie Industriali Riunite would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Given net debt is only 0.32 times EBITDA, it is initially surprising to see that CIR. - Compagnie Industriali Riunite's EBIT has low interest coverage of 0.14 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, CIR. - Compagnie Industriali Riunite's EBIT fell a jaw-dropping 91% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 CIR. - Compagnie Industriali Riunite 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, CIR. - Compagnie Industriali Riunite recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, CIR. - Compagnie Industriali Riunite's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Overall, it seems to us that CIR. - Compagnie Industriali Riunite's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. We've identified 1 warning sign with CIR. - Compagnie Industriali Riunite , and understanding them should be part of your investment process.

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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