The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Corbion N.V. (AMS:CRBN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Corbion
What Is Corbion's Net Debt?
As you can see below, at the end of December 2021, Corbion had €433.8m of debt, up from €281.9m a year ago. Click the image for more detail. However, it does have €42.2m in cash offsetting this, leading to net debt of about €391.6m.
How Strong Is Corbion's Balance Sheet?
The latest balance sheet data shows that Corbion had liabilities of €321.0m due within a year, and liabilities of €466.0m falling due after that. On the other hand, it had cash of €42.2m and €231.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €513.6m.
Corbion has a market capitalization of €2.03b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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.
Corbion's debt is 2.7 times its EBITDA, and its EBIT cover its interest expense 4.9 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The bad news is that Corbion saw its EBIT decline by 17% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Corbion's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Corbion burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
To be frank both Corbion's EBIT growth rate and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. Looking at the bigger picture, it seems clear to us that Corbion's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Be aware that Corbion is showing 3 warning signs in our investment analysis , and 2 of those are potentially serious...
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.
About ENXTAM:CRBN
Corbion
Provides lactic acid and lactic acid derivatives, other ferment, functional enzyme blends, minerals, vitamins, and algae ingredients worldwide.
Solid track record with adequate balance sheet and pays a dividend.