Is Risanamento (BIT:RN) Using Debt In A Risky Way?

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.' 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 note that Risanamento SpA (BIT:RN) does have debt on its balance sheet. 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Risanamento

What Is Risanamento's Net Debt?

As you can see below, at the end of September 2021, Risanamento had €502.3m of debt, up from €470.4m a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

A Look At Risanamento's Liabilities

The latest balance sheet data shows that Risanamento had liabilities of €27.8m due within a year, and liabilities of €595.3m falling due after that. Offsetting this, it had €4.20m in cash and €34.7m in receivables that were due within 12 months. So its liabilities total €584.3m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €263.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Risanamento would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Risanamento will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Risanamento wasn't profitable at an EBIT level, but managed to grow its revenue by 154%, to €2.1m. So there's no doubt that shareholders are cheering for growth

Caveat Emptor

While we can certainly appreciate Risanamento's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost €12m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through €32m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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 instance, we've identified 2 warning signs for Risanamento (1 is a bit concerning) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.