Subsea 7 (OB:SUBC) Seems To Use Debt Rather Sparingly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Subsea 7 S.A. (OB:SUBC) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Subsea 7

What Is Subsea 7's Debt?

As you can see below, at the end of March 2023, Subsea 7 had US$648.8m of debt, up from US$378.8m a year ago. Click the image for more detail. But it also has US$685.6m in cash to offset that, meaning it has US$36.8m net cash.

How Healthy Is Subsea 7's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Subsea 7 had liabilities of US$2.05b due within 12 months and liabilities of US$993.1m due beyond that. Offsetting these obligations, it had cash of US$685.6m as well as receivables valued at US$1.93b due within 12 months. So its liabilities total US$427.9m more than the combination of its cash and short-term receivables.

Of course, Subsea 7 has a market capitalization of US$4.03b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Subsea 7 boasts net cash, so it's fair to say it does not have a heavy debt load!

Pleasingly, Subsea 7 is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 113% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Subsea 7 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Subsea 7 does have more liabilities than liquid assets, it also has net cash of US$36.8m. And we liked the look of last year's 113% year-on-year EBIT growth. So is Subsea 7's debt a risk? It doesn't seem so to us. 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 2 warning signs for Subsea 7 you should be aware of.

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.