Is Bumech (WSE:BMC) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Bumech S.A. (WSE:BMC) does use debt in its business. But the more important question is: how much risk is that debt creating?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Bumech

What Is Bumech's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2020 Bumech had zł5.56m of debt, an increase on zł2.21m, over one year. However, it does have zł975.0k in cash offsetting this, leading to net debt of about zł4.58m.

How Healthy Is Bumech's Balance Sheet?

The latest balance sheet data shows that Bumech had liabilities of zł41.9m due within a year, and liabilities of zł44.8m falling due after that. Offsetting these obligations, it had cash of zł975.0k as well as receivables valued at zł20.2m due within 12 months. So its liabilities total zł65.5m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the zł30.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Bumech would likely require a major re-capitalisation if it had to pay its creditors today.

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). 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).

Bumech has a very low debt to EBITDA ratio of 0.34 so it is strange to see weak interest coverage, with last year's EBIT being only 1.2 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. We also note that Bumech improved its EBIT from a last year's loss to a positive zł5.0m. The balance sheet is clearly the area to focus on when you are analysing debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Bumech 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

To be frank both Bumech's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. We're quite clear that we consider Bumech to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Bumech is showing 4 warning signs in our investment analysis , and 3 of those are a bit concerning...

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. 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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