Is Class Editori (BIT:CLE) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Class Editori S.p.A. (BIT:CLE) makes use of debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Class Editori

What Is Class Editori's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Class Editori had €90.1m of debt in December 2020, down from €103.3m, one year before. However, because it has a cash reserve of €4.89m, its net debt is less, at about €85.2m.

How Healthy Is Class Editori's Balance Sheet?

The latest balance sheet data shows that Class Editori had liabilities of €102.9m due within a year, and liabilities of €94.7m falling due after that. On the other hand, it had cash of €4.89m and €67.4m worth of receivables due within a year. So it has liabilities totalling €125.3m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the €19.5m 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. At the end of the day, Class Editori would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Class Editori will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Class Editori made a loss at the EBIT level, and saw its revenue drop to €63m, which is a fall of 17%. We would much prefer see growth.

Caveat Emptor

Not only did Class Editori's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable €11m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it burned through €105k in the last year. So is this a high risk stock? We think so, and we'd avoid it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Class Editori (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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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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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