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 seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We can see that Brioschi Sviluppo Immobiliare S.p.A. (BIT:BRI) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Brioschi Sviluppo Immobiliare

What Is Brioschi Sviluppo Immobiliare’s Debt?

As you can see below, Brioschi Sviluppo Immobiliare had €49.1m of debt at September 2022, down from €182.5m a year prior. However, it does have €28.4m in cash offsetting this, leading to net debt of about €20.7m.

How Healthy Is Brioschi Sviluppo Immobiliare’s Balance Sheet?

According to the last reported balance sheet, Brioschi Sviluppo Immobiliare had liabilities of €8.83m due within 12 months, and liabilities of €147.9m due beyond 12 months. Offsetting this, it had €28.4m in cash and €1.60m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €126.7m.

This deficit casts a shadow over the €57.7m company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt. After all, Brioschi Sviluppo Immobiliare would likely require a major re-capitalisation if it had to pay its creditors today.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Brioschi Sviluppo Immobiliare has net debt of just 0.44 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 7.3 times the interest expense over the last year. It was also good to see that despite losing money on the EBIT line last year, Brioschi Sviluppo Immobiliare turned things around in the last 12 months, delivering and EBIT of €43m. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Brioschi Sviluppo Immobiliare 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So it’s worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Brioschi Sviluppo Immobiliare actually produced more free cash flow than EBIT. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.

Our View

While Brioschi Sviluppo Immobiliare’s level of total liabilities has us nervous. For example, its conversion of EBIT to free cash flow and net debt to EBITDA give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Brioschi Sviluppo Immobiliare is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For example, we’ve discovered 1 warning sign for Brioschi Sviluppo Immobiliare that you should be aware of before investing here.

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.