Is Zaklady Urzadzen Kotlowych Staporków (WSE:ZUK) A Risky Investment?

Warren Buffett famously said, '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. We note that Zaklady Urzadzen Kotlowych "Staporków" S.A. (WSE:ZUK) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for Zaklady Urzadzen Kotlowych Staporków

What Is Zaklady Urzadzen Kotlowych Staporków's Net Debt?

The image below, which you can click on for greater detail, shows that Zaklady Urzadzen Kotlowych Staporków had debt of zł6.67m at the end of June 2023, a reduction from zł15.8m over a year. However, it also had zł709.0k in cash, and so its net debt is zł5.96m.

How Healthy Is Zaklady Urzadzen Kotlowych Staporków's Balance Sheet?

The latest balance sheet data shows that Zaklady Urzadzen Kotlowych Staporków had liabilities of zł14.2m due within a year, and liabilities of zł2.85m falling due after that. Offsetting these obligations, it had cash of zł709.0k as well as receivables valued at zł6.25m due within 12 months. So it has liabilities totalling zł10.1m more than its cash and near-term receivables, combined.

Zaklady Urzadzen Kotlowych Staporków has a market capitalization of zł21.5m, 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.

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.

Looking at its net debt to EBITDA of 1.2 and interest cover of 4.7 times, it seems to us that Zaklady Urzadzen Kotlowych Staporków is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Importantly, Zaklady Urzadzen Kotlowych Staporków's EBIT fell a jaw-dropping 21% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Zaklady Urzadzen Kotlowych Staporków 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Zaklady Urzadzen Kotlowych Staporków recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Zaklady Urzadzen Kotlowych Staporków's struggle to grow its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its net debt to EBITDA is relatively strong. When we consider all the factors discussed, it seems to us that Zaklady Urzadzen Kotlowych Staporków is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 Zaklady Urzadzen Kotlowych Staporków has 4 warning signs (and 1 which is a bit concerning) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.