Hellenic Petroleum Holdings Societe Anonyme (ATH:ELPE) Seems To Be Using A Lot Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Hellenic Petroleum Holdings Societe Anonyme (ATH:ELPE) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hellenic Petroleum Holdings Societe Anonyme

What Is Hellenic Petroleum Holdings Societe Anonyme's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Hellenic Petroleum Holdings Societe Anonyme had €2.99b of debt, an increase on €2.88b, over one year. However, it also had €1.05b in cash, and so its net debt is €1.94b.

How Strong Is Hellenic Petroleum Holdings Societe Anonyme's Balance Sheet?

The latest balance sheet data shows that Hellenic Petroleum Holdings Societe Anonyme had liabilities of €3.61b due within a year, and liabilities of €2.04b falling due after that. Offsetting these obligations, it had cash of €1.05b as well as receivables valued at €619.3m due within 12 months. So its liabilities total €3.98b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the €2.13b 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. After all, Hellenic Petroleum Holdings Societe Anonyme would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Hellenic Petroleum Holdings Societe Anonyme has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 5.2 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably, Hellenic Petroleum Holdings Societe Anonyme made a loss at the EBIT level, last year, but improved that to positive EBIT of €417m in the last twelve months. 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 Hellenic Petroleum Holdings Societe Anonyme can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Hellenic Petroleum Holdings Societe Anonyme saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Hellenic Petroleum Holdings Societe Anonyme's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to cover its interest expense with its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like Hellenic Petroleum Holdings Societe Anonyme has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Hellenic Petroleum Holdings Societe Anonyme 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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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.