Is Sociedad Matriz SAAM (SNSE:SMSAAM) Using Too Much Debt?

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. We note that Sociedad Matriz SAAM S.A. (SNSE:SMSAAM) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sociedad Matriz SAAM

What Is Sociedad Matriz SAAM's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Sociedad Matriz SAAM had debt of US$603.0m, up from US$343.0m in one year. However, it also had US$316.8m in cash, and so its net debt is US$286.2m.

How Healthy Is Sociedad Matriz SAAM's Balance Sheet?

According to the last reported balance sheet, Sociedad Matriz SAAM had liabilities of US$172.8m due within 12 months, and liabilities of US$644.9m due beyond 12 months. On the other hand, it had cash of US$316.8m and US$115.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$385.6m.

While this might seem like a lot, it is not so bad since Sociedad Matriz SAAM has a market capitalization of US$763.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Sociedad Matriz SAAM's low debt to EBITDA ratio of 1.4 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.2 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. We note that Sociedad Matriz SAAM grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sociedad Matriz SAAM 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Sociedad Matriz SAAM recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Sociedad Matriz SAAM's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. We would also note that Infrastructure industry companies like Sociedad Matriz SAAM commonly do use debt without problems. When we consider the range of factors above, it looks like Sociedad Matriz SAAM is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Sociedad Matriz SAAM (of which 1 is potentially serious!) 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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