Is Sonaecom S.G.P.S (ELI:SNC) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Sonaecom, S.G.P.S., S.A. (ELI:SNC) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sonaecom S.G.P.S

How Much Debt Does Sonaecom S.G.P.S Carry?

You can click the graphic below for the historical numbers, but it shows that Sonaecom S.G.P.S had €3.69m of debt in December 2020, down from €4.82m, one year before. However, it does have €233.7m in cash offsetting this, leading to net cash of €230.0m.

How Healthy Is Sonaecom S.G.P.S' Balance Sheet?

According to the last reported balance sheet, Sonaecom S.G.P.S had liabilities of €61.4m due within 12 months, and liabilities of €71.5m due beyond 12 months. Offsetting this, it had €233.7m in cash and €39.4m in receivables that were due within 12 months. So it actually has €140.1m more liquid assets than total liabilities.

This surplus suggests that Sonaecom S.G.P.S is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Sonaecom S.G.P.S boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sonaecom S.G.P.S will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Sonaecom S.G.P.S had a loss before interest and tax, and actually shrunk its revenue by 2.3%, to €130m. That's not what we would hope to see.

So How Risky Is Sonaecom S.G.P.S?

While Sonaecom S.G.P.S lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of €60m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Sonaecom S.G.P.S , and understanding them should be part of your investment process.

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. 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.
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