Does Termo-Rex (WSE:TRR) Have A Healthy Balance Sheet?

Simply Wall St
August 10, 2021
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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. Importantly, Termo-Rex S.A. (WSE:TRR) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, 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 Termo-Rex

What Is Termo-Rex's Debt?

As you can see below, at the end of March 2021, Termo-Rex had zł6.25m of debt, up from zł2.18m a year ago. Click the image for more detail. However, it does have zł7.42m in cash offsetting this, leading to net cash of zł1.17m.

WSE:TRR Debt to Equity History August 11th 2021

How Healthy Is Termo-Rex's Balance Sheet?

We can see from the most recent balance sheet that Termo-Rex had liabilities of zł12.9m falling due within a year, and liabilities of zł4.84m due beyond that. Offsetting this, it had zł7.42m in cash and zł6.13m in receivables that were due within 12 months. So its liabilities total zł4.19m more than the combination of its cash and short-term receivables.

Given Termo-Rex has a market capitalization of zł109.0m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Termo-Rex also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Termo-Rex grew its EBIT by 7,964% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Termo-Rex will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Termo-Rex may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Termo-Rex actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Termo-Rex has zł1.17m in net cash. The cherry on top was that in converted 123% of that EBIT to free cash flow, bringing in zł1.2m. So we don't think Termo-Rex's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Termo-Rex that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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