Here's Why Repsol (BME:REP) Can Manage Its Debt Responsibly

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.' 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. We can see that Repsol, S.A. (BME:REP) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

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What Is Repsol's Net Debt?

The image below, which you can click on for greater detail, shows that Repsol had debt of €10.7b at the end of September 2022, a reduction from €11.1b over a year. But it also has €10.9b in cash to offset that, meaning it has €290.0m net cash.

How Healthy Is Repsol's Balance Sheet?

We can see from the most recent balance sheet that Repsol had liabilities of €20.1b falling due within a year, and liabilities of €16.9b due beyond that. Offsetting these obligations, it had cash of €10.9b as well as receivables valued at €10.3b due within 12 months. So it has liabilities totalling €15.8b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of €19.5b, so it does suggest shareholders should keep an eye on Repsol's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Repsol boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Repsol grew its EBIT by 159% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Repsol 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, a company can only pay off debt with cold hard cash, not accounting profits. Repsol 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 two years, Repsol produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Repsol does have more liabilities than liquid assets, it also has net cash of €290.0m. And we liked the look of last year's 159% year-on-year EBIT growth. So we are not troubled with Repsol's debt use. 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 3 warning signs for Repsol you should be aware of, and 1 of them shouldn't be ignored.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.