Does Newag (WSE:NWG) Have A Healthy Balance Sheet?

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.' 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 Newag S.A. (WSE:NWG) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Newag

How Much Debt Does Newag Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Newag had zł464.0m of debt, an increase on zł407.9m, over one year. However, it does have zł46.6m in cash offsetting this, leading to net debt of about zł417.4m.

A Look At Newag's Liabilities

According to the last reported balance sheet, Newag had liabilities of zł731.7m due within 12 months, and liabilities of zł233.2m due beyond 12 months. On the other hand, it had cash of zł46.6m and zł358.8m worth of receivables due within a year. So it has liabilities totalling zł559.5m more than its cash and near-term receivables, combined.

Newag has a market capitalization of zł1.13b, so it could very likely raise cash to ameliorate 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Newag's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its strong interest cover of 18.2 times, makes us even more comfortable. On top of that, Newag grew its EBIT by 65% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Newag's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Newag saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Newag is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Looking at all this data makes us feel a little cautious about Newag's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Newag (of which 3 shouldn't be ignored!) you should know about.

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. 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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