Is EssoF (EPA:ES) A Risky Investment?

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. As with many other companies Esso S.A.F. (EPA:ES) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

Check out our latest analysis for EssoF

What Is EssoF's Debt?

You can click the graphic below for the historical numbers, but it shows that EssoF had €23.5m of debt in June 2022, down from €170.3m, one year before. But it also has €96.7m in cash to offset that, meaning it has €73.2m net cash.

How Strong Is EssoF's Balance Sheet?

We can see from the most recent balance sheet that EssoF had liabilities of €2.63b falling due within a year, and liabilities of €1.05b due beyond that. Offsetting this, it had €96.7m in cash and €1.73b in receivables that were due within 12 months. So its liabilities total €1.85b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the €638.9m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, EssoF would probably need a major re-capitalization if its creditors were to demand repayment. EssoF boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Even more impressive was the fact that EssoF grew its EBIT by 249% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is EssoF'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While EssoF 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 two years, EssoF recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

Although EssoF's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €73.2m. And it impressed us with its EBIT growth of 249% over the last year. So while EssoF does not have a great balance sheet, it's certainly not too bad. 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. For instance, we've identified 2 warning signs for EssoF (1 is significant) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.