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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Energoinstal S.A. (WSE:ENI) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Energoinstal
What Is Energoinstal's Net Debt?
As you can see below, at the end of December 2020, Energoinstal had zł10.2m of debt, up from zł6.96m a year ago. Click the image for more detail. But on the other hand it also has zł10.8m in cash, leading to a zł613.0k net cash position.
How Strong Is Energoinstal's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Energoinstal had liabilities of zł29.2m due within 12 months and liabilities of zł18.6m due beyond that. On the other hand, it had cash of zł10.8m and zł26.4m worth of receivables due within a year. So it has liabilities totalling zł10.6m more than its cash and near-term receivables, combined.
Energoinstal has a market capitalization of zł27.5m, 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. While it does have liabilities worth noting, Energoinstal also has more cash than debt, so we're pretty confident it can manage its debt safely.
Shareholders should be aware that Energoinstal's EBIT was down 42% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is Energoinstal'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Energoinstal has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Energoinstal barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.
Summing up
While Energoinstal does have more liabilities than liquid assets, it also has net cash of zł613.0k. Despite its cash we think that Energoinstal seems to struggle to grow its EBIT, so we are wary of the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Energoinstal (including 1 which can't be ignored) .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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About WSE:ENI
Energoinstal
Engages in the manufacture and sale of power boilers in Poland and internationally.
Mediocre balance sheet low.