We Think Turism Hoteluri Restaurante Marea Neagra (BVB:EFO) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Turism, Hoteluri, Restaurante Marea Neagra S.A. (BVB:EFO) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Turism Hoteluri Restaurante Marea Neagra

What Is Turism Hoteluri Restaurante Marea Neagra's Debt?

As you can see below, at the end of September 2022, Turism Hoteluri Restaurante Marea Neagra had RON9.60m of debt, up from RON6.86m a year ago. Click the image for more detail. However, it also had RON2.00m in cash, and so its net debt is RON7.60m.

How Strong Is Turism Hoteluri Restaurante Marea Neagra's Balance Sheet?

According to the last reported balance sheet, Turism Hoteluri Restaurante Marea Neagra had liabilities of RON23.8m due within 12 months, and liabilities of RON43.8m due beyond 12 months. On the other hand, it had cash of RON2.00m and RON12.5m worth of receivables due within a year. So it has liabilities totalling RON53.1m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Turism Hoteluri Restaurante Marea Neagra has a market capitalization of RON134.8m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Turism Hoteluri Restaurante Marea Neagra has a low net debt to EBITDA ratio of only 0.14. And its EBIT easily covers its interest expense, being 371 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Turism Hoteluri Restaurante Marea Neagra grew its EBIT by 438% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Turism Hoteluri Restaurante Marea Neagra 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last two years, Turism Hoteluri Restaurante Marea Neagra created free cash flow amounting to 4.6% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Turism Hoteluri Restaurante Marea Neagra's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Turism Hoteluri Restaurante Marea Neagra can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Turism Hoteluri Restaurante Marea Neagra (of which 1 makes us a bit uncomfortable!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.