Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We can see that Portale Sardegna SpA (BIT: PSA) uses debt in its business. But the real question is whether this debt makes the business risky.
When Is Debt a Problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest review for Portale Sardegna
What is Portale Sardegna’s debt?
As you can see below, at the end of December 2020, Portale Sardegna had 8.78 million euros in debt, up from 4.62 million euros a year ago. Click on the image for more details. On the other hand, he has 3.42 million euros in cash, leading to a net debt of about 5.36 million euros.
A look at the responsibilities of Portale Sardegna
Zooming in on the latest balance sheet data, we can see that Portale Sardegna had a liability of 1.90 million euros due within 12 months and a liability of 7.37 million euros due beyond. In return, he had € 3.42 million in cash and € 1.06 million in receivables due within 12 months. Its liabilities thus exceed the sum of its cash and its receivables (short term) by 4.79 M €.
That’s a mountain of leverage compared to its market capitalization of € 5.95m. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area you need to focus on when analyzing debt. But you can’t look at debt in isolation; since Portale Sardegna will need income to repay this debt. So if you want to know more about its profits, it might be worth checking out this long term profit trend chart.
Over 12 months, Portale Sardegna recorded a loss in terms of EBIT and saw its turnover fall to € 4.3 million, a decrease of 63%. It makes us nervous, to say the least.
While Portale Sardegna’s drop in revenue is about as comforting as a wet hedge, its earnings before interest and taxes (EBIT) can be said to be even less attractive. To be precise, the EBIT loss amounted to € 449. When we look at this and recall the liabilities on its balance sheet, versus the cash flow, it seems unwise to us that the company has debt. Quite frankly, we believe the record is far from up to par, although it could improve over time. For example, we would not want to see a repeat of the loss of € 227,000 from last year. So, to be frank, we think it’s risky. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you should inquire about the 3 warning signs we spotted with Portale Sardegna (including 2 which are significant).
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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