Is SOCEP (BVB:SOCP) A Risky Investment?

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.' 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 can see that SOCEP S.A. (BVB:SOCP) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for SOCEP

How Much Debt Does SOCEP Carry?

The image below, which you can click on for greater detail, shows that SOCEP had debt of RON44.5m at the end of December 2023, a reduction from RON55.0m over a year. However, it does have RON84.4m in cash offsetting this, leading to net cash of RON39.9m.

A Look At SOCEP's Liabilities

Zooming in on the latest balance sheet data, we can see that SOCEP had liabilities of RON64.8m due within 12 months and liabilities of RON216.9m due beyond that. Offsetting this, it had RON84.4m in cash and RON63.9m in receivables that were due within 12 months. So its liabilities total RON133.4m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since SOCEP has a market capitalization of RON664.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, SOCEP also has more cash than debt, so we're pretty confident it can manage its debt safely.

SOCEP's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since SOCEP 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While SOCEP 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, SOCEP 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.

Summing Up

Although SOCEP's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of RON39.9m. So we are not troubled with SOCEP's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - SOCEP has 2 warning signs we think you should be aware of.

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.

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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.