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 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. We note that Mostostal Zabrze S.A. (WSE:MSZ) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Mostostal Zabrze's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Mostostal Zabrze had zł29.8m of debt in September 2021, down from zł42.7m, one year before. However, it does have zł41.0m in cash offsetting this, leading to net cash of zł11.2m.
How Healthy Is Mostostal Zabrze's Balance Sheet?
We can see from the most recent balance sheet that Mostostal Zabrze had liabilities of zł307.3m falling due within a year, and liabilities of zł59.8m due beyond that. Offsetting this, it had zł41.0m in cash and zł291.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł34.3m.
This deficit isn't so bad because Mostostal Zabrze is worth zł121.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Mostostal Zabrze boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Mostostal Zabrze grew its EBIT by 69% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Mostostal Zabrze will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Mostostal Zabrze 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. In the last three years, Mostostal Zabrze's free cash flow amounted to 39% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Although Mostostal Zabrze's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of zł11.2m. And we liked the look of last year's 69% year-on-year EBIT growth. So we are not troubled with Mostostal Zabrze's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Mostostal Zabrze that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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.