Compañía Chilena de Fósforos (SNSE:FOSFOROS) Seems To Use Debt Quite Sensibly

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 note that Compañía Chilena de Fósforos S.A. (SNSE:FOSFOROS) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Compañía Chilena de Fósforos

What Is Compañía Chilena de Fósforos's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Compañía Chilena de Fósforos had CL$6.67b of debt, an increase on CL$1.88b, over one year. However, its balance sheet shows it holds CL$9.63b in cash, so it actually has CL$2.96b net cash.

How Healthy Is Compañía Chilena de Fósforos' Balance Sheet?

The latest balance sheet data shows that Compañía Chilena de Fósforos had liabilities of CL$8.68b due within a year, and liabilities of CL$8.75b falling due after that. Offsetting this, it had CL$9.63b in cash and CL$5.81b in receivables that were due within 12 months. So it has liabilities totalling CL$1.99b more than its cash and near-term receivables, combined.

Since publicly traded Compañía Chilena de Fósforos shares are worth a total of CL$61.5b, 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, Compañía Chilena de Fósforos also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Compañía Chilena de Fósforos grew its EBIT by 7.2% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Compañía Chilena de Fósforos will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Compañía Chilena de Fósforos 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, Compañía Chilena de Fósforos saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Compañía Chilena de Fósforos has CL$2.96b in net cash. On top of that, it increased its EBIT by 7.2% in the last twelve months. So we don't have any problem with Compañía Chilena de Fósforos's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Compañía Chilena de Fósforos (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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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