Is Compa (BVB:CMP) Using Too Much Debt?

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.' 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 note that Compa S.A. (BVB:CMP) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Compa

What Is Compa's Net Debt?

As you can see below, at the end of September 2022, Compa had RON122.4m of debt, up from RON99.1m a year ago. Click the image for more detail. However, it also had RON4.71m in cash, and so its net debt is RON117.7m.

How Healthy Is Compa's Balance Sheet?

According to the last reported balance sheet, Compa had liabilities of RON151.9m due within 12 months, and liabilities of RON142.3m due beyond 12 months. Offsetting these obligations, it had cash of RON4.71m as well as receivables valued at RON160.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RON128.7m.

Given this deficit is actually higher than the company's market capitalization of RON100.5m, we think shareholders really should watch Compa's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Compa 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.

Over 12 months, Compa saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Importantly, Compa had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost RON4.4m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through RON21m in negative free cash flow over the last year. That means it's on the risky side of things. 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. We've identified 3 warning signs with Compa (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

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.

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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.