Stock Analysis

These 4 Measures Indicate That OMV Petrom (BVB:SNP) Is Using Debt Reasonably Well

BVB:SNP
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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. Importantly, OMV Petrom S.A. (BVB:SNP) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 OMV Petrom

How Much Debt Does OMV Petrom Carry?

You can click the graphic below for the historical numbers, but it shows that OMV Petrom had RON239.6m of debt in September 2021, down from RON270.0m, one year before. However, it does have RON9.10b in cash offsetting this, leading to net cash of RON8.86b.

debt-equity-history-analysis
BVB:SNP Debt to Equity History November 11th 2021

How Strong Is OMV Petrom's Balance Sheet?

We can see from the most recent balance sheet that OMV Petrom had liabilities of RON7.36b falling due within a year, and liabilities of RON8.42b due beyond that. On the other hand, it had cash of RON9.10b and RON1.72b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RON4.97b.

Given OMV Petrom has a market capitalization of RON28.6b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, OMV Petrom also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, OMV Petrom saw its EBIT drop by 4.1% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 OMV Petrom can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. OMV Petrom may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, OMV Petrom recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While OMV Petrom does have more liabilities than liquid assets, it also has net cash of RON8.86b. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in RON3.6b. So we don't have any problem with OMV Petrom's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for OMV Petrom that you should be aware of before investing here.

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.

Valuation is complex, but we're helping make it simple.

Find out whether OMV Petrom is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.

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