Is Subsea 7 (OB:SUBC) Using Too Much Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Subsea 7 S.A. (OB:SUBC) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

View our latest analysis for Subsea 7

What Is Subsea 7's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Subsea 7 had US$362.1m of debt, an increase on US$190.6m, over one year. But on the other hand it also has US$532.9m in cash, leading to a US$170.8m net cash position.

How Healthy Is Subsea 7's Balance Sheet?

We can see from the most recent balance sheet that Subsea 7 had liabilities of US$1.95b falling due within a year, and liabilities of US$617.0m due beyond that. On the other hand, it had cash of US$532.9m and US$1.78b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$249.4m.

Since publicly traded Subsea 7 shares are worth a total of US$3.13b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Subsea 7 boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Subsea 7's EBIT was down 76% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Subsea 7's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Subsea 7 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 most recent two years, Subsea 7 recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Subsea 7 has US$170.8m in net cash. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in US$302m. So we are not troubled with Subsea 7's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Subsea 7's earnings per share history for free.

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.