These 4 measures indicate that Socovesa (SNSE: SOCOVESA) uses debt in a risky way

Warren Buffett said: “Volatility is far from synonymous with risk”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We note that Socovesa SA (SNSE: SOCOVESA) has a debt on its balance sheet. But does this debt worry shareholders?

Why Does Debt Bring Risk?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.

See our latest review for Socovesa

What is Socovesa’s debt?

The image below, which you can click for more details, shows that Socovesa had CL $ 489.0 billion in debt at the end of June 2021, a reduction from CL $ 551.0 billion on a year. On the other hand, it has CL $ 24.5 billion in cash, resulting in net debt of around CL $ 464.6 billion.

SNSE: SOCOVESA History of debt on equity 23 November 2021

Is Socovesa’s track record healthy?

The latest balance sheet data shows that Socovesa had liabilities of CL $ 597.3 billion due within one year, and CL $ 32.6 billion liabilities due thereafter. In return, he had CL $ 24.5 billion in cash and CL $ 116.0 billion in receivables due within 12 months. It therefore has liabilities totaling C $ 489.4 billion more than its cash and short-term receivables combined.

This deficit casts a shadow over the CL $ 135.3 billion company like a towering colossus of mere mortals. We therefore believe that shareholders should watch it closely. After all, Socovesa would likely need a major recapitalization if it were to pay its creditors today.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

It turns out that Socovesa has a rather worrying net debt to EBITDA ratio of 14.5 but very strong interest coverage of 88.2. So either he has access to very cheap long-term debt or his interest charges will go up! It is important to note that Socovesa’s EBIT has fallen by 39% over the past twelve months. If this profit trend continues, paying off debt will be about as easy as driving cats on a roller coaster. When analyzing debt levels, the balance sheet is the obvious starting point. But it is Socovesa’s results that will influence the way the balance sheet is held in the future. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Socovesa has recorded significant negative free cash flow overall. While investors no doubt expect this situation to reverse in due course, this clearly means its use of debt is riskier.

Our point of view

At first glance, Socovesa’s EBIT growth rate left us hesitant about the stock, and its total liability level was no more appealing than the single empty restaurant on the busiest night of the year. But on the bright side, his interest coverage is a good sign and makes us more optimistic. Taking into account all the factors mentioned above, we believe that Socovesa is really too much in debt. For us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may think differently. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 4 warning signs for Socovesa (2 of which are of concern!) that you should know about.

At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

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John A. Bogar