Warren Buffett said: “Volatility is far from synonymous with risk. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that Moliera2 SA (WSE:MO2) uses debt in its business. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies 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.
Discover our latest analysis for Moliera2
What is Moliera’s2 debt?
The image below, which you can click on for more details, shows that in December 2021, Moliera2 had a debt of 12.8 million zł, compared to 2.72 million zł in one year. On the other hand, it has 8.13 million zł of liquid assets, which results in a net debt of approximately 4.66 million zł.
How healthy is Moliera2’s balance sheet?
We can see from the most recent balance sheet that Moliera2 had liabilities of 25.1 million zł due in one year, and liabilities of 5.44 million zł due beyond. On the other hand, he had liquid assets of 8.13 million zł and receivables worth 2.33 million zł within one year. Thus, its liabilities total 20.1 million zł more than the combination of its cash and short-term receivables.
Moliera2 has a market cap of 98.8 million zł, so it could most likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay debt.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Moliera2’s net debt is only 0.53 times its EBITDA. And its EBIT easily covers its interest charges, which is 12.7 times the size. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Its low leverage may become crucial for Moliera2 if management cannot prevent a repeat of the 71% drop in EBIT over the past year. When it comes to paying off debt, lower income is no more helpful than sugary sodas for your health. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since Moliera2 will need income to repay this debt. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
Finally, a company can only repay its debts with cold hard cash, not with book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past two years, Moliera2 has burned a lot of money. While investors are no doubt expecting a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
Neither Moliera2’s ability to grow EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But the good news is that it seems to be able to easily cover its interest costs with its EBIT. Considering the above factors, we believe that Moliera2’s debt poses certain risks to the business. So even if this leverage increases return on equity, we wouldn’t really want to see it increase from now on. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 4 warning signs for Moliera2 (2 cannot be ignored) which you should be aware of.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.