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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Seko S.A. (WSE:SEK) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Seko
What Is Seko's Debt?
The image below, which you can click on for greater detail, shows that Seko had debt of zł21.6m at the end of September 2022, a reduction from zł23.7m over a year. On the flip side, it has zł16.5m in cash leading to net debt of about zł5.11m.
How Healthy Is Seko's Balance Sheet?
According to the last reported balance sheet, Seko had liabilities of zł37.6m due within 12 months, and liabilities of zł20.2m due beyond 12 months. On the other hand, it had cash of zł16.5m and zł25.9m worth of receivables due within a year. So it has liabilities totalling zł15.5m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Seko has a market capitalization of zł49.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Seko'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.
Over 12 months, Seko reported revenue of zł208m, which is a gain of 6.5%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Caveat Emptor
Importantly, Seko had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at zł1.0m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through zł10m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Seko has 4 warning signs (and 3 which are potentially serious) we think you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.
About WSE:SEK
Flawless balance sheet established dividend payer.
