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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. 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?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Recordati Industria Chimica e Farmaceutica

What Is Recordati Industria Chimica e Farmaceutica's Debt?

As you can see below, Recordati Industria Chimica e Farmaceutica had €1.64b of debt at June 2024, down from €1.84b a year prior. On the flip side, it has €200.6m in cash leading to net debt of about €1.44b.

A Look At Recordati Industria Chimica e Farmaceutica's Liabilities

The latest balance sheet data shows that Recordati Industria Chimica e Farmaceutica had liabilities of €887.2m due within a year, and liabilities of €1.51b falling due after that. On the other hand, it had cash of €200.6m and €592.2m worth of receivables due within a year. So its liabilities total €1.60b more than the combination of its cash and short-term receivables.

Since publicly traded Recordati Industria Chimica e Farmaceutica shares are worth a very impressive total of €10.3b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Recordati Industria Chimica e Farmaceutica's net debt of 1.8 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.3 times interest expense) certainly does not do anything to dispel this impression. We saw Recordati Industria Chimica e Farmaceutica grow its EBIT by 8.6% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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'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 it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Recordati Industria Chimica e Farmaceutica recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

On this analysis, Recordati Industria Chimica e Farmaceutica's interest cover was a real positive, just like an unsolicited gift of cupcakes from a work colleague. And its apparent ability to to convert EBIT to free cash flow is also rather rousing! All these things considered, it appears that Recordati Industria Chimica e Farmaceutica can comfortably handle its current debt levels. 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. 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 2 warning signs with Recordati Industria Chimica e Farmaceutica , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.