Is Balticon (WSE:BLT) Using Too Much Debt?

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.' 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. As with many other companies Balticon S.A. (WSE:BLT) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Balticon

What Is Balticon's Net Debt?

The image below, which you can click on for greater detail, shows that Balticon had debt of zł13.6m at the end of September 2021, a reduction from zł23.3m over a year. However, it also had zł662.8k in cash, and so its net debt is zł13.0m.

How Healthy Is Balticon's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Balticon had liabilities of zł32.8m due within 12 months and liabilities of zł22.1m due beyond that. Offsetting these obligations, it had cash of zł662.8k as well as receivables valued at zł28.6m due within 12 months. So it has liabilities totalling zł25.6m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of zł41.9m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Balticon's net debt is only 0.71 times its EBITDA. And its EBIT covers its interest expense a whopping 16.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Balticon grew its EBIT by 37% 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 it is Balticon'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Balticon recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Balticon's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Balticon can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. We've identified 2 warning signs with Balticon (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.