These 4 Measures Indicate That Petros Petropoulos AEBE (ATH:PETRO) Is Using Debt Extensively

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.' 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 Petros Petropoulos AEBE (ATH:PETRO) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Petros Petropoulos AEBE

What Is Petros Petropoulos AEBE's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Petros Petropoulos AEBE had debt of €25.2m, up from €15.0m in one year. However, because it has a cash reserve of €11.0m, its net debt is less, at about €14.2m.

How Healthy Is Petros Petropoulos AEBE's Balance Sheet?

The latest balance sheet data shows that Petros Petropoulos AEBE had liabilities of €22.9m due within a year, and liabilities of €17.5m falling due after that. Offsetting this, it had €11.0m in cash and €26.9m in receivables that were due within 12 months. So its liabilities total €2.50m more than the combination of its cash and short-term receivables.

Of course, Petros Petropoulos AEBE has a market capitalization of €37.9m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Petros Petropoulos AEBE has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 3.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Petros Petropoulos AEBE improved its EBIT by 4.1% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. But it is Petros Petropoulos AEBE'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Petros Petropoulos AEBE burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Petros Petropoulos AEBE's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its level of total liabilities is relatively strong. Taking the abovementioned factors together we do think Petros Petropoulos AEBE's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Petros Petropoulos AEBE (at least 2 which are a bit unpleasant) , and understanding them should be part of your investment process.

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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