We Think Recordati Industria Chimica e Farmaceutica (BIT:REC) Can Stay On Top Of Its Debt

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.' 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. 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?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Recordati Industria Chimica e Farmaceutica

What Is Recordati Industria Chimica e Farmaceutica's Debt?

As you can see below, at the end of September 2023, Recordati Industria Chimica e Farmaceutica had €1.79b of debt, up from €1.70b a year ago. Click the image for more detail. However, because it has a cash reserve of €302.3m, its net debt is less, at about €1.49b.

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

Zooming in on the latest balance sheet data, we can see that Recordati Industria Chimica e Farmaceutica had liabilities of €955.6m due within 12 months and liabilities of €1.55b due beyond that. On the other hand, it had cash of €302.3m and €477.0m worth of receivables due within a year. So its liabilities total €1.73b more than the combination of its cash and short-term receivables.

Of course, Recordati Industria Chimica e Farmaceutica has a titanic market capitalization of €9.91b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Recordati Industria Chimica e Farmaceutica's net debt of 2.1 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 9.2 times its interest expenses harmonizes with that theme. If Recordati Industria Chimica e Farmaceutica can keep growing EBIT at last year's rate of 16% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, Recordati Industria Chimica e Farmaceutica produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Recordati Industria Chimica e Farmaceutica's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! Looking at all the aforementioned factors together, it strikes us that Recordati Industria Chimica e Farmaceutica can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. For example - Recordati Industria Chimica e Farmaceutica has 2 warning signs we think 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.