AS Pro Kapital Grupp (TAL:PKG1T) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, AS Pro Kapital Grupp (TAL:PKG1T) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for AS Pro Kapital Grupp

What Is AS Pro Kapital Grupp's Net Debt?

As you can see below, AS Pro Kapital Grupp had €53.9m of debt at March 2022, down from €137.4m a year prior. On the flip side, it has €7.65m in cash leading to net debt of about €46.2m.

How Strong Is AS Pro Kapital Grupp's Balance Sheet?

We can see from the most recent balance sheet that AS Pro Kapital Grupp had liabilities of €35.7m falling due within a year, and liabilities of €39.1m due beyond that. Offsetting these obligations, it had cash of €7.65m as well as receivables valued at €2.07m due within 12 months. So it has liabilities totalling €65.1m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's €53.9m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

AS Pro Kapital Grupp shareholders face the double whammy of a high net debt to EBITDA ratio (9.2), and fairly weak interest coverage, since EBIT is just 0.82 times the interest expense. This means we'd consider it to have a heavy debt load. The silver lining is that AS Pro Kapital Grupp grew its EBIT by 4,740% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. When analysing debt levels, the balance sheet is the obvious place to start. But it is AS Pro Kapital Grupp'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, AS Pro Kapital Grupp actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

We feel some trepidation about AS Pro Kapital Grupp's difficulty interest cover, but we've got positives to focus on, too. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that AS Pro Kapital Grupp is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with AS Pro Kapital Grupp (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

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. 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.