Is BasicNet (BIT:BAN) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, BasicNet S.p.A. (BIT:BAN) does carry debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 BasicNet

How Much Debt Does BasicNet Carry?

As you can see below, BasicNet had €83.8m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have €22.3m in cash offsetting this, leading to net debt of about €61.5m.

A Look At BasicNet's Liabilities

Zooming in on the latest balance sheet data, we can see that BasicNet had liabilities of €128.0m due within 12 months and liabilities of €69.3m due beyond that. On the other hand, it had cash of €22.3m and €59.4m worth of receivables due within a year. So its liabilities total €115.7m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because BasicNet is worth €311.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

BasicNet's net debt is 3.3 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 12.1 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Pleasingly, BasicNet is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 182% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since BasicNet 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.

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 last three years, BasicNet actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, BasicNet's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. Looking at the bigger picture, we think BasicNet's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for BasicNet that 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.