Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to consider debt when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Rainbow Tours SA (WSE: RBW) uses debt in its operations. But does this debt worry shareholders?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Rainbow Tours
How much debt does Rainbow Tours have?
The image below, which you can click on for more details, shows that Rainbow Tours had a debt of 108.2 million zł at the end of March 2022, a reduction from 161.2 million zł year-on-year. However, he also had 81.3 million zł of cash, and therefore his net debt is 26.9 million zł.
How healthy is Rainbow Tours’ balance sheet?
We can see from the most recent balance sheet that Rainbow Tours had liabilities of 347.5 million zł due in one year, and liabilities of 112.9 million zł due beyond. On the other hand, he had a cash position of 81.3 million zł and 221.3 million zł of receivables due within the year. It therefore has liabilities totaling zł 157.6 million more than its cash and short-term receivables, combined.
This shortfall is not that serious as Rainbow Tours is worth zł302.7 million and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Rainbow Tours’ net debt is only 0.80 times its EBITDA. And its EBIT covers its interest charges 14.1 times. So we’re pretty relaxed about his super-conservative use of debt. It was also good to see that despite losing money on the EBIT line last year, Rainbow Tours turned the tide in the last 12 months, delivering an EBIT of 22 million zł. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Rainbow Tours will need income to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Fortunately for all shareholders, Rainbow Tours has actually produced more free cash flow than EBIT over the past year. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
Fortunately, Rainbow Tours’ impressive interest coverage means it has the upper hand on its debt. But truth be told, we think his total passive level undermines that impression a bit. Looking at all of the aforementioned factors together, it seems to us that Rainbow Tours can manage its debt quite comfortably. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. To do this, you need to find out about the 2 warning signs we spotted some with Rainbow Tours (including 1 that is significant).
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.