Semapa - Sociedade de Investimento e Gestão SGPS (ELI:SEM) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Semapa - Sociedade de Investimento e Gestão, SGPS, S.A. (ELI:SEM) does have debt on its balance sheet. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Semapa - Sociedade de Investimento e Gestão SGPS

How Much Debt Does Semapa - Sociedade de Investimento e Gestão SGPS Carry?

The chart below, which you can click on for greater detail, shows that Semapa - Sociedade de Investimento e Gestão SGPS had €1.34b in debt in September 2024; about the same as the year before. However, it does have €217.4m in cash offsetting this, leading to net debt of about €1.12b.

How Strong Is Semapa - Sociedade de Investimento e Gestão SGPS' Balance Sheet?

We can see from the most recent balance sheet that Semapa - Sociedade de Investimento e Gestão SGPS had liabilities of €1.41b falling due within a year, and liabilities of €1.67b due beyond that. Offsetting these obligations, it had cash of €217.4m as well as receivables valued at €639.3m due within 12 months. So its liabilities total €2.23b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €1.26b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Semapa - Sociedade de Investimento e Gestão SGPS 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).

Semapa - Sociedade de Investimento e Gestão SGPS's net debt of 1.7 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.6 times its interest expenses harmonizes with that theme. On the other hand, Semapa - Sociedade de Investimento e Gestão SGPS saw its EBIT drop by 2.9% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Semapa - Sociedade de Investimento e Gestão SGPS 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Semapa - Sociedade de Investimento e Gestão SGPS produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

We'd go so far as to say Semapa - Sociedade de Investimento e Gestão SGPS's level of total liabilities was disappointing. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Semapa - Sociedade de Investimento e Gestão SGPS stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Semapa - Sociedade de Investimento e Gestão SGPS (1 is a bit unpleasant!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.