Here's Why P.A. Nova (WSE:NVA) Is Weighed Down By Its Debt Load

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.' 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. Importantly, P.A. Nova S.A. (WSE:NVA) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 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 P.A. Nova

What Is P.A. Nova's Debt?

The chart below, which you can click on for greater detail, shows that P.A. Nova had zł300.2m in debt in June 2024; about the same as the year before. On the flip side, it has zł59.4m in cash leading to net debt of about zł240.8m.

How Strong Is P.A. Nova's Balance Sheet?

The latest balance sheet data shows that P.A. Nova had liabilities of zł128.5m due within a year, and liabilities of zł293.0m falling due after that. On the other hand, it had cash of zł59.4m and zł60.6m worth of receivables due within a year. So its liabilities total zł301.5m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the zł137.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, P.A. Nova would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

P.A. Nova has a debt to EBITDA ratio of 4.5 and its EBIT covered its interest expense 3.1 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, P.A. Nova's EBIT was down 24% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is P.A. Nova'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 company can only pay off debt with cold hard cash, not accounting profits. 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, P.A. Nova's free cash flow amounted to 48% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both P.A. Nova's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. Taking into account all the aforementioned factors, it looks like P.A. Nova has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for P.A. Nova (of which 1 makes us a bit uncomfortable!) you should know about.

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.

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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.