These 4 Measures Indicate That Orlen (WSE:PKN) Is Using Debt Reasonably Well

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. As with many other companies Orlen S.A. (WSE:PKN) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Orlen

What Is Orlen's Debt?

As you can see below, Orlen had zł17.2b of debt at March 2023, down from zł18.7b a year prior. However, it does have zł32.1b in cash offsetting this, leading to net cash of zł14.9b.

A Look At Orlen's Liabilities

Zooming in on the latest balance sheet data, we can see that Orlen had liabilities of zł92.5b due within 12 months and liabilities of zł36.1b due beyond that. On the other hand, it had cash of zł32.1b and zł46.8b worth of receivables due within a year. So its liabilities total zł49.6b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of zł77.4b, so it does suggest shareholders should keep an eye on Orlen's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Orlen boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Orlen grew its EBIT by 190% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Orlen's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Orlen has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Orlen's free cash flow amounted to 48% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While Orlen does have more liabilities than liquid assets, it also has net cash of zł14.9b. And we liked the look of last year's 190% year-on-year EBIT growth. So we are not troubled with Orlen's debt use. 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. For instance, we've identified 4 warning signs for Orlen (2 don't sit too well with us) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.