Is Gielda Praw Majatkowych Vindexus Spolka Akcyjna (WSE:VIN) 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 Gielda Praw Majatkowych Vindexus Spolka Akcyjna (WSE:VIN) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Gielda Praw Majatkowych Vindexus Spolka Akcyjna

What Is Gielda Praw Majatkowych Vindexus Spolka Akcyjna's Debt?

The image below, which you can click on for greater detail, shows that Gielda Praw Majatkowych Vindexus Spolka Akcyjna had debt of zł61.2m at the end of December 2020, a reduction from zł99.2m over a year. However, it also had zł34.6m in cash, and so its net debt is zł26.7m.

How Healthy Is Gielda Praw Majatkowych Vindexus Spolka Akcyjna's Balance Sheet?

According to the last reported balance sheet, Gielda Praw Majatkowych Vindexus Spolka Akcyjna had liabilities of zł43.4m due within 12 months, and liabilities of zł58.6m due beyond 12 months. Offsetting these obligations, it had cash of zł34.6m as well as receivables valued at zł8.65m due within 12 months. So it has liabilities totalling zł58.8m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of zł68.8m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Even though Gielda Praw Majatkowych Vindexus Spolka Akcyjna's debt is only 1.6, its interest cover is really very low at 2.3. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. The bad news is that Gielda Praw Majatkowych Vindexus Spolka Akcyjna saw its EBIT decline by 16% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. 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 Gielda Praw Majatkowych Vindexus Spolka Akcyjna will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Gielda Praw Majatkowych Vindexus Spolka Akcyjna's free cash flow amounted to 48% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On the face of it, Gielda Praw Majatkowych Vindexus Spolka Akcyjna's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Looking at the bigger picture, it seems clear to us that Gielda Praw Majatkowych Vindexus Spolka Akcyjna's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Gielda Praw Majatkowych Vindexus Spolka Akcyjna (of which 1 makes us a bit uncomfortable!) you should know about.

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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