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.' 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, Culti Milano S.p.A. (BIT:CULT) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Culti Milano's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2020 Culti Milano had debt of €4.02m, up from none in one year. But it also has €4.43m in cash to offset that, meaning it has €418.7k net cash.
A Look At Culti Milano's Liabilities
The latest balance sheet data shows that Culti Milano had liabilities of €4.84m due within a year, and liabilities of €4.21m falling due after that. On the other hand, it had cash of €4.43m and €3.30m worth of receivables due within a year. So its liabilities total €1.32m more than the combination of its cash and short-term receivables.
Given Culti Milano has a market capitalization of €15.9m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Culti Milano boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Culti Milano made a loss at the EBIT level, last year, it was also good to see that it generated €632k in EBIT over the last twelve months. 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 Culti Milano 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Culti Milano may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Culti Milano actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
We could understand if investors are concerned about Culti Milano's liabilities, but we can be reassured by the fact it has has net cash of €418.7k. The cherry on top was that in converted 287% of that EBIT to free cash flow, bringing in €1.8m. So is Culti Milano's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 2 warning signs we've spotted with Culti Milano .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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