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 note that Krynicki Recykling Spólka Akcyjna (WSE:KRC) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Krynicki Recykling Spólka Akcyjna's Debt?
The image below, which you can click on for greater detail, shows that Krynicki Recykling Spólka Akcyjna had debt of zł53.5m at the end of December 2020, a reduction from zł56.0m over a year. Net debt is about the same, since the it doesn't have much cash.
How Healthy Is Krynicki Recykling Spólka Akcyjna's Balance Sheet?
According to the last reported balance sheet, Krynicki Recykling Spólka Akcyjna had liabilities of zł31.8m due within 12 months, and liabilities of zł93.3m due beyond 12 months. Offsetting these obligations, it had cash of zł146.1k as well as receivables valued at zł19.5m due within 12 months. So its liabilities total zł105.5m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Krynicki Recykling Spólka Akcyjna is worth zł319.5m, and thus could probably raise enough capital to shore up 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Krynicki Recykling Spólka Akcyjna's net debt of 1.9 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.6 times interest expense) certainly does not do anything to dispel this impression. Importantly, Krynicki Recykling Spólka Akcyjna grew its EBIT by 31% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Krynicki Recykling Spólka Akcyjna'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Krynicki Recykling Spólka Akcyjna's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Happily, Krynicki Recykling Spólka Akcyjna's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. All these things considered, it appears that Krynicki Recykling Spólka Akcyjna 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. 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 - Krynicki Recykling Spólka Akcyjna has 3 warning signs we think you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
If you decide to trade Krynicki Recykling Spólka Akcyjna, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.