Is Grodno Spólka Akcyjna (WSE:GRN) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Grodno Spólka Akcyjna (WSE:GRN) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Grodno Spólka Akcyjna

What Is Grodno Spólka Akcyjna's Debt?

As you can see below, at the end of June 2023, Grodno Spólka Akcyjna had zł113.0m of debt, up from zł84.0m a year ago. Click the image for more detail. However, it also had zł4.91m in cash, and so its net debt is zł108.1m.

A Look At Grodno Spólka Akcyjna's Liabilities

We can see from the most recent balance sheet that Grodno Spólka Akcyjna had liabilities of zł329.3m falling due within a year, and liabilities of zł38.6m due beyond that. Offsetting these obligations, it had cash of zł4.91m as well as receivables valued at zł170.4m due within 12 months. So its liabilities total zł192.5m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's zł163.4m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Grodno Spólka Akcyjna has a debt to EBITDA ratio of 2.9 and its EBIT covered its interest expense 4.0 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Worse, Grodno Spólka Akcyjna's EBIT was down 51% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is Grodno Spólka Akcyjna'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Grodno Spólka Akcyjna basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

Mulling over Grodno Spólka Akcyjna's attempt at (not) growing its EBIT, we're certainly not enthusiastic. And furthermore, its interest cover also fails to instill confidence. Taking into account all the aforementioned factors, it looks like Grodno Spólka Akcyjna has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Grodno Spólka Akcyjna (including 1 which doesn't sit too well with us) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.