Is Recordati Industria Chimica e Farmaceutica (BIT:REC) A Risky Investment?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Recordati Industria Chimica e Farmaceutica S.p.A. (BIT:REC) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out the opportunities and risks within the XX Pharmaceuticals industry.

How Much Debt Does Recordati Industria Chimica e Farmaceutica Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Recordati Industria Chimica e Farmaceutica had debt of €1.70b, up from €1.05b in one year. However, because it has a cash reserve of €346.6m, its net debt is less, at about €1.35b.

A Look At Recordati Industria Chimica e Farmaceutica's Liabilities

We can see from the most recent balance sheet that Recordati Industria Chimica e Farmaceutica had liabilities of €778.0m falling due within a year, and liabilities of €1.59b due beyond that. On the other hand, it had cash of €346.6m and €443.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.58b.

Since publicly traded Recordati Industria Chimica e Farmaceutica shares are worth a total of €8.52b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that Recordati Industria Chimica e Farmaceutica's moderate net debt to EBITDA ratio ( being 2.2), indicates prudence when it comes to debt. And its strong interest cover of 18.7 times, makes us even more comfortable. We saw Recordati Industria Chimica e Farmaceutica grow its EBIT by 7.6% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 Recordati Industria Chimica e Farmaceutica 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. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Recordati Industria Chimica e Farmaceutica recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

When it comes to the balance sheet, the standout positive for Recordati Industria Chimica e Farmaceutica was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. For example, its net debt to EBITDA makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that Recordati Industria Chimica e Farmaceutica is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Recordati Industria Chimica e Farmaceutica .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.