Is Enervit (BIT: ENV) Using Too Much Debt?

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David Iben expressed it well when he said: “Volatility is not a risk that is close to our hearts. What matters to us is to avoid the permanent loss of capital. ‘ When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Above all, Enervit SpA (BIT: ENV) carries a debt. But the real question is whether this debt makes the business risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. 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. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.

See our latest review for Enervit

What is Enervit’s net debt?

The image below, which you can click for more details, shows that Enervit had a debt of 18.5 million euros at the end of June 2021, compared to 21.1 million euros over a year. However, because it has a cash reserve of € 14.5 million, its net debt is lower, at around € 4.01 million.

BIT: ENV History of debt to equity 20 October 2021

A look at the responsibilities of Enervit

The latest balance sheet data shows that Enervit had debts of € 21.5 million due within one year, and debts of € 20.8 million due thereafter. On the other hand, it had cash of € 14.5 million and € 16.4 million in receivables within one year. Its liabilities thus exceed the sum of its cash and its receivables (short term) by € 11.3 million.

Considering that the listed Enervit shares are worth a total of 69.8 million euros, it seems unlikely that this level of liabilities is a major threat. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time.

We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Enervit’s net debt is only 0.58 times its EBITDA. And its EBIT covers its interest costs a whopping 10.9 times more. So we’re pretty relaxed about its ultra-conservative use of debt. Although Enervit recorded a loss in EBIT, last year it was also good to see that it generated 3.3 million euros of EBIT in the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Enervit can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Over the past year, Enervit has actually generated more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.

Our point of view

Fortunately, Enervit’s impressive conversion of EBIT to free cash flow means that it has the upper hand over its debt. And that’s just the start of the good news since its coverage of interest is also very encouraging. Looking at the big picture, we think Enervit’s use of debt looks very reasonable and we don’t care. After all, reasonable leverage can increase returns on equity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. To this end, you should inquire about the 3 warning signs we spotted with Enervit (including 1 which does not suit us too well).

If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow net-growth stocks.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.

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