Does Rainbow Tours (WSE:RBW) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Rainbow Tours S.A. (WSE:RBW) does use debt in its business. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Rainbow Tours

What Is Rainbow Tours's Net Debt?

As you can see below, Rainbow Tours had zł73.9m of debt at March 2023, down from zł108.2m a year prior. However, it also had zł67.3m in cash, and so its net debt is zł6.60m.

How Healthy Is Rainbow Tours' Balance Sheet?

According to the last reported balance sheet, Rainbow Tours had liabilities of zł493.1m due within 12 months, and liabilities of zł106.5m due beyond 12 months. Offsetting this, it had zł67.3m in cash and zł48.6m in receivables that were due within 12 months. So its liabilities total zł483.6m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of zł553.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Carrying virtually no net debt, Rainbow Tours has a very light debt load indeed.

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).

Rainbow Tours has barely any net debt, as demonstrated by its net debt to EBITDA ratio of only 0.09. Happily, it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt as easily as enthusiastic spray-tanners take on an orange hue. Even more impressive was the fact that Rainbow Tours grew its EBIT by 198% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Rainbow Tours's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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 two years, Rainbow Tours actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, Rainbow Tours's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at the bigger picture, we think Rainbow Tours'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. 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 example Rainbow Tours has 2 warning signs (and 1 which is concerning) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.