We Think Brunello Cucinelli (BIT:BC) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Brunello Cucinelli S.p.A. (BIT:BC) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Brunello Cucinelli

How Much Debt Does Brunello Cucinelli Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Brunello Cucinelli had debt of €166.2m, up from €108.1m in one year. However, because it has a cash reserve of €73.0m, its net debt is less, at about €93.1m.

How Strong Is Brunello Cucinelli's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Brunello Cucinelli had liabilities of €310.8m due within 12 months and liabilities of €507.8m due beyond that. Offsetting these obligations, it had cash of €73.0m as well as receivables valued at €102.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €642.8m.

Brunello Cucinelli has a market capitalization of €2.51b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

Given net debt is only 0.75 times EBITDA, it is initially surprising to see that Brunello Cucinelli's EBIT has low interest coverage of 1.1 times. So one way or the other, it's clear the debt levels are not trivial. Shareholders should be aware that Brunello Cucinelli's EBIT was down 76% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Brunello Cucinelli 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Brunello Cucinelli recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

While Brunello Cucinelli's interest cover makes us cautious about it, its track record of (not) growing its EBIT is no better. But on the brighter side of life, its net debt to EBITDA leaves us feeling more frolicsome. When we consider all the factors discussed, it seems to us that Brunello Cucinelli is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Brunello Cucinelli is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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.
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