Stock Analysis

We Think OMV Petrom (BVB:SNP) Can Manage Its Debt With Ease

BVB:SNP
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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, OMV Petrom S.A. (BVB:SNP) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for OMV Petrom

What Is OMV Petrom's Net Debt?

As you can see below, OMV Petrom had RON252.6m of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has RON12.2b in cash to offset that, meaning it has RON11.9b net cash.

debt-equity-history-analysis
BVB:SNP Debt to Equity History May 26th 2022

How Strong Is OMV Petrom's Balance Sheet?

According to the last reported balance sheet, OMV Petrom had liabilities of RON9.60b due within 12 months, and liabilities of RON7.12b due beyond 12 months. Offsetting these obligations, it had cash of RON12.2b as well as receivables valued at RON3.29b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RON1.24b.

Of course, OMV Petrom has a market capitalization of RON25.4b, so these liabilities are probably manageable. 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.

Better yet, OMV Petrom grew its EBIT by 340% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While OMV Petrom has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, OMV Petrom recorded free cash flow worth a fulsome 96% 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

We could understand if investors are concerned about OMV Petrom's liabilities, but we can be reassured by the fact it has has net cash of RON11.9b. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in RON5.7b. So is OMV Petrom's debt a risk? It doesn't seem so to us. 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 OMV Petrom (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.