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.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Remedy Entertainment Oyj (HEL:REMEDY) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Remedy Entertainment Oyj Carry?
As you can see below, Remedy Entertainment Oyj had €3.67m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds €23.7m in cash, so it actually has €20.0m net cash.
How Strong Is Remedy Entertainment Oyj’s Balance Sheet?
The latest balance sheet data shows that Remedy Entertainment Oyj had liabilities of €10.2m due within a year, and liabilities of €2.76m falling due after that. Offsetting this, it had €23.7m in cash and €3.89m in receivables that were due within 12 months. So it actually has €14.6m more liquid assets than total liabilities.
This short term liquidity is a sign that Remedy Entertainment Oyj could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Remedy Entertainment Oyj boasts net cash, so it’s fair to say it does not have a heavy debt load!
Better yet, Remedy Entertainment Oyj grew its EBIT by 102% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Remedy Entertainment Oyj’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Remedy Entertainment Oyj has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Remedy Entertainment Oyj recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While we empathize with investors who find debt concerning, you should keep in mind that Remedy Entertainment Oyj has net cash of €20.0m, as well as more liquid assets than liabilities. And we liked the look of last year’s 102% year-on-year EBIT growth. So we don’t think Remedy Entertainment Oyj’s use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We’ve spotted 1 warning sign for Remedy Entertainment Oyj you should be aware of.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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