We Think SFC Energy (ETR:F3C) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that SFC Energy AG (ETR:F3C) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for SFC Energy

What Is SFC Energy's Net Debt?

The image below, which you can click on for greater detail, shows that SFC Energy had debt of €3.86m at the end of June 2022, a reduction from €4.02m over a year. But it also has €13.9m in cash to offset that, meaning it has €10.0m net cash.

A Look At SFC Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that SFC Energy had liabilities of €26.2m due within 12 months and liabilities of €13.5m due beyond that. On the other hand, it had cash of €13.9m and €20.9m worth of receivables due within a year. So it has liabilities totalling €4.89m more than its cash and near-term receivables, combined.

Having regard to SFC Energy's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the €311.1m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, SFC Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, SFC Energy's EBIT fell a jaw-dropping 25% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if SFC Energy 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. SFC Energy 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. During the last three years, SFC Energy burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that SFC Energy has €10.0m in net cash. Despite its cash we think that SFC Energy seems to struggle to grow its EBIT, so we are wary of the stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for SFC Energy that you should be aware of.

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.