Here's Why Bumech (WSE:BMC) Has A Meaningful Debt Burden

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 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. Importantly, Bumech S.A. (WSE:BMC) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Bumech

How Much Debt Does Bumech Carry?

As you can see below, Bumech had zł5.72m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have zł1.70m in cash offsetting this, leading to net debt of about zł4.02m.

How Strong Is Bumech's Balance Sheet?

We can see from the most recent balance sheet that Bumech had liabilities of zł35.5m falling due within a year, and liabilities of zł42.5m due beyond that. Offsetting this, it had zł1.70m in cash and zł24.2m in receivables that were due within 12 months. So it has liabilities totalling zł52.1m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of zł45.0m, we think shareholders really should watch Bumech's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Given net debt is only 0.27 times EBITDA, it is initially surprising to see that Bumech's EBIT has low interest coverage of 0.83 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, Bumech's EBIT launched higher than Elon Musk, gaining a whopping 381% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Bumech 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last two years, Bumech's free cash flow amounted to 33% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

While Bumech's interest cover has us nervous. To wit both its EBIT growth rate and net debt to EBITDA were encouraging signs. When we consider all the factors discussed, it seems to us that Bumech 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. 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. To that end, you should be aware of the 1 warning sign we've spotted with Bumech .

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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