Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Instal Kraków S.A. (WSE:INK) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Instal Kraków's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Instal Kraków had zł8.46m of debt in December 2020, down from zł13.8m, one year before. But it also has zł93.7m in cash to offset that, meaning it has zł85.2m net cash.
A Look At Instal Kraków's Liabilities
We can see from the most recent balance sheet that Instal Kraków had liabilities of zł98.1m falling due within a year, and liabilities of zł27.9m due beyond that. Offsetting these obligations, it had cash of zł93.7m as well as receivables valued at zł58.3m due within 12 months. So it actually has zł26.0m more liquid assets than total liabilities.
This short term liquidity is a sign that Instal Kraków could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Instal Kraków boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Instal Kraków if management cannot prevent a repeat of the 24% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Instal Kraków'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. Instal Kraków may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Instal Kraków produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Instal Kraków has net cash of zł85.2m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of zł77m, being 78% of its EBIT. So we don't have any problem with Instal Kraków's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Instal Kraków that you should be aware of before investing here.
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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