Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Sevenet SA (WSE:SEV) uses debt in its operations. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
See our latest analysis for Sevenet
What is Sevenet’s debt?
The image below, which you can click on for more details, shows that Sevenet had a debt of 7.65 million zł at the end of September 2021, a reduction from 13.5 million zł over one year. But on the other hand, it also has 16.9 million zł of liquid assets, which translates into a net cash position of 9.23 million zł.
How strong is Sevenet’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Sevenet had liabilities of 37.4 million zł due within 12 months and liabilities of 19.9 million zł due beyond. In return, it had zł 16.9 million in cash and zł 30.2 million in receivables due within 12 months. Thus, its liabilities total zł 10.2 million more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not that bad since Sevenet has a market capitalization of zł26.0 million, so it could probably strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at your ability to repay debt. Despite its notable liabilities, Sevenet has a net cash position, so it’s fair to say that it doesn’t have a lot of debt! The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since Sevenet will need income to repay this debt. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
Last year, Sevenet recorded a loss before interest and taxes and actually reduced its income by 42%, to 71 million zł. It makes us nervous, to say the least.
So how risky is Sevenet?
While Sevenet lost money in earnings before interest and taxes (EBIT), it actually recorded a paper profit of 152,000 zł. So if you consider it has net cash, plus statutory earnings, the stock probably isn’t as risky as it looks, at least in the short term. Until we see a positive EBIT, we are a little cautious on the stock, especially given the rather modest revenue growth. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example Sevenet has 6 warning signs (and 2 that make us uncomfortable) that we think you should know about.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.
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