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.' 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, B.V. Delftsch Aardewerkfabriek "De Porceleyne Fles Anno 1653" (AMS:PORF) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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.
What Is B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653's Debt?
The image below, which you can click on for greater detail, shows that at December 2021 B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653 had debt of €15.6m, up from €14.1m in one year. However, it does have €4.03m in cash offsetting this, leading to net debt of about €11.5m.
How Strong Is B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653's Balance Sheet?
We can see from the most recent balance sheet that B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653 had liabilities of €2.78m falling due within a year, and liabilities of €15.3m due beyond that. Offsetting these obligations, it had cash of €4.03m as well as receivables valued at €3.90m due within 12 months. So its liabilities total €10.2m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of €11.0m, so it does suggest shareholders should keep an eye on B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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.
B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653 has a rather high debt to EBITDA ratio of 8.6 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.8 times, suggesting it can responsibly service its obligations. However, the silver lining was that B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653 achieved a positive EBIT of €703k in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653's earnings that will influence how the balance sheet holds up in the future. 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653 generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653's net debt to EBITDA and interest cover definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for B.V. Delftsch Aardewerkfabriek De Porceleyne Fles Anno 1653 (1 makes us a bit uncomfortable) you should be aware of.
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.