We Think Petro Rio (BVMF:PRIO3) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Petro Rio S.A. (BVMF:PRIO3) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Petro Rio

What Is Petro Rio's Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Petro Rio had debt of R$3.31b, up from R$1.91b in one year. However, it does have R$4.65b in cash offsetting this, leading to net cash of R$1.34b.

How Strong Is Petro Rio's Balance Sheet?

According to the last reported balance sheet, Petro Rio had liabilities of R$1.09b due within 12 months, and liabilities of R$4.52b due beyond 12 months. Offsetting this, it had R$4.65b in cash and R$1.00b in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Petro Rio's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the R$21.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Petro Rio boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Petro Rio grew its EBIT by 127% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Petro Rio can strengthen its balance sheet over time. 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. Petro Rio may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Petro Rio reported free cash flow worth 8.5% 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

While we empathize with investors who find debt concerning, you should keep in mind that Petro Rio has net cash of R$1.34b, as well as more liquid assets than liabilities. And we liked the look of last year's 127% year-on-year EBIT growth. So we are not troubled with Petro Rio's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Petro Rio's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.