Is South Ocean Holdings (JSE:SOH) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, South Ocean Holdings Limited (JSE:SOH) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for South Ocean Holdings

What Is South Ocean Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 South Ocean Holdings had debt of R47.3m, up from R43.9m in one year. But on the other hand it also has R142.5m in cash, leading to a R95.2m net cash position.

A Look At South Ocean Holdings' Liabilities

The latest balance sheet data shows that South Ocean Holdings had liabilities of R113.0m due within a year, and liabilities of R75.2m falling due after that. Offsetting these obligations, it had cash of R142.5m as well as receivables valued at R195.8m due within 12 months. So it can boast R150.1m more liquid assets than total liabilities.

This luscious liquidity implies that South Ocean Holdings' balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that South Ocean Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, South Ocean Holdings grew its EBIT by 204% 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 it is South Ocean Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While South Ocean Holdings 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 most recent two years, South Ocean Holdings recorded free cash flow worth 54% 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.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that South Ocean Holdings has net cash of R95.2m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 204% over the last year. The bottom line is that we do not find South Ocean Holdings's debt levels at all concerning. 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. For example, we've discovered 3 warning signs for South Ocean Holdings that you should be aware of before investing here.

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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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.