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 can see that CNTEE Transelectrica SA (BVB:TEL) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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 think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does CNTEE Transelectrica Carry?
As you can see below, CNTEE Transelectrica had RON171.1m of debt at December 2020, down from RON181.8m a year prior. But on the other hand it also has RON569.8m in cash, leading to a RON398.8m net cash position.
A Look At CNTEE Transelectrica's Liabilities
Zooming in on the latest balance sheet data, we can see that CNTEE Transelectrica had liabilities of RON1.07b due within 12 months and liabilities of RON697.3m due beyond that. Offsetting this, it had RON569.8m in cash and RON855.5m in receivables that were due within 12 months. So its liabilities total RON345.4m more than the combination of its cash and short-term receivables.
Of course, CNTEE Transelectrica has a market capitalization of RON1.77b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, CNTEE Transelectrica boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that CNTEE Transelectrica has boosted its EBIT by 55%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CNTEE Transelectrica can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While CNTEE Transelectrica has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, CNTEE Transelectrica actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While CNTEE Transelectrica does have more liabilities than liquid assets, it also has net cash of RON398.8m. And it impressed us with free cash flow of RON233m, being 133% of its EBIT. So we don't think CNTEE Transelectrica'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. We've identified 1 warning sign with CNTEE Transelectrica , and understanding them should be part of your investment process.
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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