These 4 Measures Indicate That Sociedad Punta del Cobre (SNSE:PUCOBRE) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Sociedad Punta del Cobre S.A. (SNSE:PUCOBRE) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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.

See our latest analysis for Sociedad Punta del Cobre

What Is Sociedad Punta del Cobre's Net Debt?

As you can see below, at the end of September 2020, Sociedad Punta del Cobre had US$35.4m of debt, up from US$2.52m a year ago. Click the image for more detail. But on the other hand it also has US$48.9m in cash, leading to a US$13.5m net cash position.

How Healthy Is Sociedad Punta del Cobre's Balance Sheet?

According to the last reported balance sheet, Sociedad Punta del Cobre had liabilities of US$98.5m due within 12 months, and liabilities of US$87.0m due beyond 12 months. Offsetting these obligations, it had cash of US$48.9m as well as receivables valued at US$51.2m due within 12 months. So its liabilities total US$85.4m more than the combination of its cash and short-term receivables.

Given Sociedad Punta del Cobre has a market capitalization of US$724.3m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Sociedad Punta del Cobre boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Sociedad Punta del Cobre has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sociedad Punta del Cobre's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sociedad Punta del Cobre 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, Sociedad Punta del Cobre reported free cash flow worth 5.8% 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

Although Sociedad Punta del Cobre's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$13.5m. And it impressed us with its EBIT growth of 23% over the last year. So we don't have any problem with Sociedad Punta del Cobre's use of debt. 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. Case in point: We've spotted 1 warning sign for Sociedad Punta del Cobre you should be aware of.

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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