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

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies INA-Industrija nafte, d.d. (ZGSE:INA) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 examine debt levels, we first consider both cash and debt levels, together.

See 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 €421.4m of debt at June 2023, down from €593.3m a year prior. On the flip side, it has €90.8m in cash leading to net debt of about €330.6m.

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 €876.6m falling due within a year, and liabilities of €809.5m due beyond that. Offsetting this, it had €90.8m in cash and €336.0m in receivables that were due within 12 months. So its liabilities total €1.26b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since INA-Industrija nafte d.d has a market capitalization of €4.42b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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.

INA-Industrija nafte d.d's net debt is only 0.77 times its EBITDA. And its EBIT easily covers its interest expense, being 585 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for INA-Industrija nafte d.d if management cannot prevent a repeat of the 46% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is INA-Industrija nafte d.d'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, INA-Industrija nafte d.d recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Neither INA-Industrija nafte d.d's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that INA-Industrija nafte d.d 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. 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. For instance, we've identified 3 warning signs for INA-Industrija nafte d.d (2 can't be ignored) 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.