We Think Zaklady Urzadzen Kotlowych Staporków (WSE:ZUK) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 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?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

View our latest analysis for Zaklady Urzadzen Kotlowych Staporków

How Much Debt Does Zaklady Urzadzen Kotlowych Staporków Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Zaklady Urzadzen Kotlowych Staporków had debt of zł11.9m, up from zł2.15m in one year. However, because it has a cash reserve of zł1.22m, its net debt is less, at about zł10.6m.

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

We can see from the most recent balance sheet that Zaklady Urzadzen Kotlowych Staporków had liabilities of zł20.0m falling due within a year, and liabilities of zł3.21m due beyond that. Offsetting this, it had zł1.22m in cash and zł11.1m in receivables that were due within 12 months. So it has liabilities totalling zł10.9m more than its cash and near-term receivables, combined.

Zaklady Urzadzen Kotlowych Staporków has a market capitalization of zł37.1m, 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 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Zaklady Urzadzen Kotlowych Staporków's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 10.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Zaklady Urzadzen Kotlowych Staporków grew its EBIT by 117% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Zaklady Urzadzen Kotlowych Staporków reported free cash flow worth 11% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Zaklady Urzadzen Kotlowych Staporków's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Zaklady Urzadzen Kotlowych Staporków can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Zaklady Urzadzen Kotlowych Staporków has 4 warning signs (and 3 which are a bit unpleasant) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.