INA-Industrija nafte d.d (ZGSE:INA) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that INA-Industrija nafte, d.d. (ZGSE:INA) does have debt on its balance sheet. 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for INA-Industrija nafte d.d

What Is INA-Industrija nafte d.d's Net Debt?

As you can see below, INA-Industrija nafte d.d had €443.8m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have €159.4m in cash offsetting this, leading to net debt of about €284.4m.

How Strong Is INA-Industrija nafte d.d's Balance Sheet?

We can see from the most recent balance sheet that INA-Industrija nafte d.d had liabilities of €970.2m falling due within a year, and liabilities of €822.2m due beyond that. Offsetting these obligations, it had cash of €159.4m as well as receivables valued at €383.2m due within 12 months. So its liabilities total €1.25b more than the combination of its cash and short-term receivables.

INA-Industrija nafte d.d has a market capitalization of €4.70b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

INA-Industrija nafte d.d has a low net debt to EBITDA ratio of only 0.81. And its EBIT covers its interest expense a whopping 40.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that INA-Industrija nafte d.d's load is not too heavy, because its EBIT was down 74% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since INA-Industrija nafte d.d will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, INA-Industrija nafte d.d produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

INA-Industrija nafte d.d's EBIT growth rate 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. Looking at all this data makes us feel a little cautious about INA-Industrija nafte d.d's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 - INA-Industrija nafte d.d has 3 warning signs we think you should be aware of.

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.