Polski Koncern Naftowy ORLEN Spólka Akcyjna (WSE:PKN) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Polski Koncern Naftowy ORLEN Spólka Akcyjna (WSE:PKN) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Polski Koncern Naftowy ORLEN Spólka Akcyjna

How Much Debt Does Polski Koncern Naftowy ORLEN Spólka Akcyjna Carry?

As you can see below, at the end of September 2022, Polski Koncern Naftowy ORLEN Spólka Akcyjna had zł16.4b of debt, up from zł14.4b a year ago. Click the image for more detail. However, it also had zł15.3b in cash, and so its net debt is zł1.15b.

How Strong Is Polski Koncern Naftowy ORLEN Spólka Akcyjna's Balance Sheet?

We can see from the most recent balance sheet that Polski Koncern Naftowy ORLEN Spólka Akcyjna had liabilities of zł58.2b falling due within a year, and liabilities of zł23.4b due beyond that. On the other hand, it had cash of zł15.3b and zł29.7b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł36.6b.

Polski Koncern Naftowy ORLEN Spólka Akcyjna has a very large market capitalization of zł72.5b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With debt at a measly 0.038 times EBITDA and EBIT covering interest a whopping 64.7 times, it's clear that Polski Koncern Naftowy ORLEN Spólka Akcyjna is not a desperate borrower. So relative to past earnings, the debt load seems trivial. Better yet, Polski Koncern Naftowy ORLEN Spólka Akcyjna grew its EBIT by 219% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Polski Koncern Naftowy ORLEN Spólka Akcyjna can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. Looking at the most recent three years, Polski Koncern Naftowy ORLEN Spólka Akcyjna recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Polski Koncern Naftowy ORLEN Spólka Akcyjna's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Polski Koncern Naftowy ORLEN Spólka Akcyjna can handle its debt fairly comfortably. 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Polski Koncern Naftowy ORLEN Spólka Akcyjna you should be aware of, and 3 of them are significant.

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.