We Think CEZ Distribution Bulgaria AD (BUL:3CZ) Can Stay On Top Of Its Debt

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies CEZ Distribution Bulgaria AD (BUL:3CZ) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for CEZ Distribution Bulgaria AD

What Is CEZ Distribution Bulgaria AD's Net Debt?

The chart below, which you can click on for greater detail, shows that CEZ Distribution Bulgaria AD had лв156.2m in debt in June 2020; about the same as the year before. On the flip side, it has лв54.9m in cash leading to net debt of about лв101.3m.

How Healthy Is CEZ Distribution Bulgaria AD's Balance Sheet?

According to the last reported balance sheet, CEZ Distribution Bulgaria AD had liabilities of лв180.8m due within 12 months, and liabilities of лв126.8m due beyond 12 months. Offsetting this, it had лв54.9m in cash and лв58.4m in receivables that were due within 12 months. So its liabilities total лв194.3m more than the combination of its cash and short-term receivables.

CEZ Distribution Bulgaria AD has a market capitalization of лв455.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

CEZ Distribution Bulgaria AD's net debt is only 0.72 times its EBITDA. And its EBIT covers its interest expense a whopping 57.3 times over. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that CEZ Distribution Bulgaria AD grew its EBIT by 335% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is CEZ Distribution Bulgaria AD's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, CEZ Distribution Bulgaria AD saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

CEZ Distribution Bulgaria AD's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. It's also worth noting that CEZ Distribution Bulgaria AD is in the Electric Utilities industry, which is often considered to be quite defensive. When we consider all the elements mentioned above, it seems to us that CEZ Distribution Bulgaria AD is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with CEZ Distribution Bulgaria AD .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.
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