Is Petro Rio (BVMF:PRIO3) A Risky Investment?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Petro Rio S.A. (BVMF:PRIO3) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Petro Rio

What Is Petro Rio's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Petro Rio had R$5.56b of debt, an increase on R$3.43b, over one year. However, its balance sheet shows it holds R$6.56b in cash, so it actually has R$995.2m net cash.

How Strong Is Petro Rio's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Petro Rio had liabilities of R$972.8m due within 12 months and liabilities of R$7.15b due beyond that. Offsetting these obligations, it had cash of R$6.56b as well as receivables valued at R$933.5m due within 12 months. So it has liabilities totalling R$627.8m more than its cash and near-term receivables, combined.

Since publicly traded Petro Rio shares are worth a total of R$20.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Petro Rio also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Petro Rio grew its EBIT by 111% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Petro Rio can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Petro Rio 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 last three years, Petro Rio reported free cash flow worth 17% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

We could understand if investors are concerned about Petro Rio's liabilities, but we can be reassured by the fact it has has net cash of R$995.2m. And it impressed us with its EBIT growth of 111% over the last year. So is Petro Rio's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Petro Rio you should know about.

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