Does Naftna Industrija Srbije a.d (BELEX:NIIS) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Naftna Industrija Srbije a.d. (BELEX:NIIS) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Naftna Industrija Srbije a.d

How Much Debt Does Naftna Industrija Srbije a.d Carry?

As you can see below, Naftna Industrija Srbije a.d had дин89.8b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have дин15.1b in cash offsetting this, leading to net debt of about дин74.7b.

A Look At Naftna Industrija Srbije a.d's Liabilities

The latest balance sheet data shows that Naftna Industrija Srbije a.d had liabilities of дин54.6b due within a year, and liabilities of дин96.1b falling due after that. Offsetting this, it had дин15.1b in cash and дин22.0b in receivables that were due within 12 months. So it has liabilities totalling дин113.7b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of дин96.2b, we think shareholders really should watch Naftna Industrija Srbije a.d's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Naftna Industrija Srbije a.d's net debt to EBITDA ratio of 3.4, we think its super-low interest cover of 1.0 times is a sign of high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, Naftna Industrija Srbije a.d's EBIT was down 95% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Naftna Industrija Srbije a.d's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Naftna Industrija Srbije a.d created free cash flow amounting to 9.6% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Naftna Industrija Srbije a.d's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And even its conversion of EBIT to free cash flow fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Naftna Industrija Srbije a.d has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Case in point: We've spotted 1 warning sign for Naftna Industrija Srbije a.d you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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