Here's Why Luka Ploce d.d (ZGSE:LKPC) Can Manage Its Debt Responsibly

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 can see that Luka Ploce d.d. (ZGSE:LKPC) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Luka Ploce d.d

What Is Luka Ploce d.d's Net Debt?

As you can see below, Luka Ploce d.d had Kn100.2m of debt at June 2021, down from Kn178.8m a year prior. On the flip side, it has Kn82.2m in cash leading to net debt of about Kn18.1m.

How Healthy Is Luka Ploce d.d's Balance Sheet?

The latest balance sheet data shows that Luka Ploce d.d had liabilities of Kn19.8m due within a year, and liabilities of Kn136.1m falling due after that. Offsetting these obligations, it had cash of Kn82.2m as well as receivables valued at Kn91.9m due within 12 months. So it can boast Kn18.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Luka Ploce d.d could probably pay off its debt with ease, as its balance sheet is far from stretched.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Luka Ploce d.d's low debt to EBITDA ratio of 0.44 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.4 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Although Luka Ploce d.d made a loss at the EBIT level, last year, it was also good to see that it generated Kn27m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Luka Ploce d.d's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Looking at the most recent year, Luka Ploce d.d recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Luka Ploce d.d's impressive net debt to EBITDA implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. It's also worth noting that Luka Ploce d.d is in the Infrastructure industry, which is often considered to be quite defensive. All these things considered, it appears that Luka Ploce d.d can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with Luka Ploce d.d .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.

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