We believe that SC Romcarbon (BVB: ROCE) is taking risks with its debt

Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Above all, SC Romcarbon SA (BVB: ROCE) is in debt. But should shareholders be concerned about its use of debt?

When is debt dangerous?

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. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.

See our latest review for SC Romcarbon

How much debt does SC Romcarbon have?

As you can see below, SC Romcarbon had 67.2 million RON in debt in June 2021, compared to 78.7 million RON a year earlier. However, since it has a cash reserve of RON 8.72 million, its net debt is lower, at around RON 58.5 million.

BVB: ROCE History of debt to equity October 12, 2021

How strong is SC Romcarbon’s balance sheet?

The latest balance sheet data show that SC Romcarbon had debts of RON 106.0 million due within one year, and RON 38.9 million debts due thereafter. In return, he had RON 8.72 million in cash and RON 52.7 million in receivables due within 12 months. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by RON 83.4 million.

Since this deficit is actually greater than the company’s market capitalization of RON 72.4 million, we believe shareholders should really watch SC Romcarbon’s debt levels, like a parent watching their child do. cycling for the first time. Hypothetically, an extremely high dilution would be necessary if the company were forced to repay its debts by raising capital at the current share price.

We measure a company’s debt load relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (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).

SC Romcarbon has a debt / EBITDA ratio of 2.5 and its EBIT covers its interest expense 5.7 times. This suggests that while debt levels are significant, we would stop calling them problematic. It should be noted that SC Romcarbon’s EBIT has soared like bamboo after the rain, gaining 41% in the last twelve months. This will make it easier to manage your debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the results of SC Romcarbon that will influence the balance sheet 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. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. In the last two years, SC Romcarbon has posted free cash flow of 17% of its EBIT, which is really quite low. For us, the conversion to cash that elicits a bit of paranoia is the ability to extinguish debt.

Our point of view

SC Romcarbon’s level of total liabilities and conversion of EBIT to free cash flow certainly weighs on it, in our view. But the good news is that he seems to be able to increase his EBIT with ease. Taking the above factors together, we believe that SC Romcarbon’s debt presents certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 4 warning signs for SC Romcarbon (2 are significant!) That you should know before investing here.

At the end of the day, it’s often best to focus on businesses with no 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 material. Simply Wall St has no position in the mentioned stocks.

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