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 Orsero S.p.A. (BIT:ORS) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Orsero
How Much Debt Does Orsero Carry?
As you can see below, at the end of September 2020, Orsero had €129.7m of debt, up from €119.3m a year ago. Click the image for more detail. However, it does have €45.8m in cash offsetting this, leading to net debt of about €83.8m.
How Healthy Is Orsero's Balance Sheet?
According to the last reported balance sheet, Orsero had liabilities of €207.8m due within 12 months, and liabilities of €131.1m due beyond 12 months. Offsetting these obligations, it had cash of €45.8m as well as receivables valued at €157.0m due within 12 months. So its liabilities total €136.0m more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's €114.6m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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.
With a debt to EBITDA ratio of 2.0, Orsero uses debt artfully but responsibly. And the alluring interest cover (EBIT of 8.1 times interest expense) certainly does not do anything to dispel this impression. Notably, Orsero's EBIT launched higher than Elon Musk, gaining a whopping 178% on last year. 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 Orsero can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept 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, Orsero 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
We'd go so far as to say Orsero's conversion of EBIT to free cash flow was disappointing. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Orsero's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 Orsero is showing 3 warning signs in our investment analysis , you should know about...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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About BIT:ORS
Orsero
Imports and distributes fruits and vegetables in Europe, Latin America, and Central America.
Very undervalued with flawless balance sheet.