David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 PITECO S.p.A. (BIT:PITE) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. When we think about a company's use of debt, we first look at cash and debt together.
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How Much Debt Does PITECO Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2018 PITECO had €21.1m of debt, an increase on €11.7m, over one year. However, it also had €5.57m in cash, and so its net debt is €15.5m.
How Healthy Is PITECO's Balance Sheet?
The latest balance sheet data shows that PITECO had liabilities of €10.4m due within a year, and liabilities of €30.5m falling due after that. On the other hand, it had cash of €5.57m and €5.31m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €30.0m.
While this might seem like a lot, it is not so bad since PITECO has a market capitalization of €89.8m, 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.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).