CIR. - Compagnie Industriali Riunite (BIT:CIR) Use Of Debt Could Be Considered Risky

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 can see that CIR S.p.A. - Compagnie Industriali Riunite (BIT:CIR) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for CIR. - Compagnie Industriali Riunite

What Is CIR. - Compagnie Industriali Riunite's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 CIR. - Compagnie Industriali Riunite had €966.4m of debt, an increase on €879.3m, over one year. However, it also had €723.2m in cash, and so its net debt is €243.2m.

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

According to the last reported balance sheet, CIR. - Compagnie Industriali Riunite had liabilities of €1.02b due within 12 months, and liabilities of €1.61b due beyond 12 months. Offsetting these obligations, it had cash of €723.2m as well as receivables valued at €291.4m due within 12 months. So it has liabilities totalling €1.61b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the €580.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. 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.

CIR. - Compagnie Industriali Riunite has a very low debt to EBITDA ratio of 1.4 so it is strange to see weak interest coverage, with last year's EBIT being only 0.97 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Importantly, CIR. - Compagnie Industriali Riunite's EBIT fell a jaw-dropping 35% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine CIR. - Compagnie Industriali Riunite's ability to maintain a healthy balance sheet going forward. 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. During the last three years, CIR. - Compagnie Industriali Riunite burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

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. We think the chances that CIR. - Compagnie Industriali Riunite has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with CIR. - Compagnie Industriali Riunite (at least 3 which are a bit unpleasant) , and understanding them should be part of your investment process.

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.

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