Is S.C. Electroarges (BVB:ELGS) A Risky Investment?

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. As with many other companies S.C. Electroarges S.A. (BVB:ELGS) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for S.C. Electroarges

How Much Debt Does S.C. Electroarges Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 S.C. Electroarges had RON43.8m of debt, an increase on RON9.28m, over one year. However, because it has a cash reserve of RON5.20m, its net debt is less, at about RON38.6m.

How Strong Is S.C. Electroarges' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that S.C. Electroarges had liabilities of RON49.6m due within 12 months and liabilities of RON15.8m due beyond that. Offsetting these obligations, it had cash of RON5.20m as well as receivables valued at RON8.09m due within 12 months. So its liabilities total RON52.1m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the RON26.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, S.C. Electroarges 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

S.C. Electroarges has a low net debt to EBITDA ratio of only 0.39. And its EBIT easily covers its interest expense, being 111 times the size. So we're pretty relaxed about its super-conservative use of debt. Although S.C. Electroarges made a loss at the EBIT level, last year, it was also good to see that it generated RON89m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since S.C. Electroarges 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, S.C. Electroarges recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, S.C. Electroarges's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, we think it's fair to say that S.C. Electroarges has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for S.C. Electroarges you should be aware of.

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.