Erbud (WSE:ERB) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Erbud S.A. (WSE:ERB) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Erbud

How Much Debt Does Erbud Carry?

You can click the graphic below for the historical numbers, but it shows that Erbud had zł88.2m of debt in December 2020, down from zł187.6m, one year before. However, it does have zł292.6m in cash offsetting this, leading to net cash of zł204.4m.

How Strong Is Erbud's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Erbud had liabilities of zł813.7m due within 12 months and liabilities of zł75.7m due beyond that. Offsetting this, it had zł292.6m in cash and zł588.1m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Erbud's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the zł744.0m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Erbud also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Erbud grew its EBIT by 17% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Erbud can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Erbud 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. Happily for any shareholders, Erbud actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

We could understand if investors are concerned about Erbud's liabilities, but we can be reassured by the fact it has has net cash of zł204.4m. The cherry on top was that in converted 128% of that EBIT to free cash flow, bringing in zł291m. So we don't think Erbud's use of debt is risky. 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. Case in point: We've spotted 2 warning signs for Erbud you should be aware of, and 1 of them doesn't sit too well with us.

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. 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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