Is Atlanta Poland (WSE:ATP) Using Too Much Debt?

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. We can see that Atlanta Poland S.A. (WSE:ATP) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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How Much Debt Does Atlanta Poland Carry?

As you can see below, at the end of June 2022, Atlanta Poland had zł45.7m of debt, up from zł40.6m a year ago. Click the image for more detail. However, it also had zł4.84m in cash, and so its net debt is zł40.9m.

A Look At Atlanta Poland's Liabilities

We can see from the most recent balance sheet that Atlanta Poland had liabilities of zł96.9m falling due within a year, and liabilities of zł6.08m due beyond that. On the other hand, it had cash of zł4.84m and zł38.5m worth of receivables due within a year. So its liabilities total zł59.6m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's zł53.0m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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).

Atlanta Poland has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 3.8 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. More concerning, Atlanta Poland saw its EBIT drop by 3.5% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. There's no doubt that we learn most about debt from the balance sheet. But it is Atlanta Poland'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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Atlanta Poland produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Mulling over Atlanta Poland's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least its conversion of EBIT to free cash flow is not so bad. Overall, we think it's fair to say that Atlanta Poland has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Be aware that Atlanta Poland is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...

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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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.