Recordati Industria Chimica e Farmaceutica (BIT:REC) Has A Pretty Healthy Balance Sheet

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. As with many other companies Recordati Industria Chimica e Farmaceutica S.p.A. (BIT:REC) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Recordati Industria Chimica e Farmaceutica

What Is Recordati Industria Chimica e Farmaceutica's Net Debt?

The image below, which you can click on for greater detail, shows that Recordati Industria Chimica e Farmaceutica had debt of €1.05b at the end of September 2021, a reduction from €1.12b over a year. However, because it has a cash reserve of €341.9m, its net debt is less, at about €706.3m.

How Healthy Is Recordati Industria Chimica e Farmaceutica's Balance Sheet?

According to the last reported balance sheet, Recordati Industria Chimica e Farmaceutica had liabilities of €610.6m due within 12 months, and liabilities of €873.8m due beyond 12 months. On the other hand, it had cash of €341.9m and €345.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €796.9m.

Of course, Recordati Industria Chimica e Farmaceutica has a titanic market capitalization of €11.0b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Recordati Industria Chimica e Farmaceutica's net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 27.2 times the size. So we're pretty relaxed about its super-conservative use of debt. Recordati Industria Chimica e Farmaceutica's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Recordati Industria Chimica e Farmaceutica recorded free cash flow of 33% 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 conversion of EBIT to free cash flow 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. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Recordati Industria Chimica e Farmaceutica that you should be aware of.

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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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.