These 4 Measures Indicate That INA-Industrija nafte d.d (ZGSE:INA) Is Using Debt Reasonably Well

Warren Buffett famously said, '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. We note that INA-Industrija nafte, d.d. (ZGSE:INA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

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

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

The image below, which you can click on for greater detail, shows that INA-Industrija nafte d.d had debt of Kn2.97b at the end of March 2021, a reduction from Kn3.99b over a year. However, because it has a cash reserve of Kn250.0m, its net debt is less, at about Kn2.72b.

How Healthy 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 Kn7.26b falling due within a year, and liabilities of Kn4.24b due beyond that. Offsetting this, it had Kn250.0m in cash and Kn2.38b in receivables that were due within 12 months. So its liabilities total Kn8.87b more than the combination of its cash and short-term receivables.

INA-Industrija nafte d.d has a market capitalization of Kn32.0b, 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 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.

While INA-Industrija nafte d.d has a quite reasonable net debt to EBITDA multiple of 1.6, its interest cover seems weak, at 1.6. The main reason for this is that it has such high depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) In any case, it's safe to say the company has meaningful debt. Pleasingly, INA-Industrija nafte d.d is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 155% gain in the last twelve months. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, INA-Industrija nafte d.d 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

INA-Industrija nafte d.d's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its interest cover. Taking all this data into account, it seems to us that INA-Industrija nafte d.d takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. While INA-Industrija nafte d.d didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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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