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.' 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. As with many other companies Petrol d.d. (LJSE:PETG) makes use of debt. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Petrol d.d
What Is Petrol d.d's Net Debt?
The image below, which you can click on for greater detail, shows that Petrol d.d had debt of €307.3m at the end of September 2020, a reduction from €369.4m over a year. However, because it has a cash reserve of €67.8m, its net debt is less, at about €239.5m.
A Look At Petrol d.d's Liabilities
We can see from the most recent balance sheet that Petrol d.d had liabilities of €498.6m falling due within a year, and liabilities of €399.4m due beyond that. Offsetting these obligations, it had cash of €67.8m as well as receivables valued at €336.9m due within 12 months. So its liabilities total €493.4m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of €758.5m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Petrol d.d's net debt to EBITDA ratio of about 1.5 suggests only moderate use of debt. And its commanding EBIT of 20.3 times its interest expense, implies the debt load is as light as a peacock feather. In fact Petrol d.d's saving grace is its low debt levels, because its EBIT has tanked 38% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Petrol d.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 it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Petrol d.d recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Petrol d.d's EBIT growth rate and level of total liabilities definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Petrol d.d is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Petrol d.d's dividend history, without delay!
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
When trading Petrol d.d or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted
New: Manage All Your Stock Portfolios in One Place
We've created the ultimate portfolio companion for stock investors, and it's free.
• Connect an unlimited number of Portfolios and see your total in one currency
• Be alerted to new Warning Signs or Risks via email or mobile
• Track the Fair Value of your stocks
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
About LJSE:PETG
Petrol d.d
Through its subsidiaries, sells petroleum and other energy products in Slovenia and internationally.
Flawless balance sheet with solid track record and pays a dividend.