Does Ciech (WSE:CIE) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Ciech S.A. (WSE:CIE) does carry 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. 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.

View our latest analysis for Ciech

What Is Ciech's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Ciech had zł1.87b of debt, an increase on zł1.72b, over one year. However, it also had zł444.5m in cash, and so its net debt is zł1.42b.

How Healthy Is Ciech's Balance Sheet?

The latest balance sheet data shows that Ciech had liabilities of zł1.10b due within a year, and liabilities of zł2.16b falling due after that. On the other hand, it had cash of zł444.5m and zł440.6m worth of receivables due within a year. So it has liabilities totalling zł2.37b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of zł1.70b, we think shareholders really should watch Ciech's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Ciech's moderate net debt to EBITDA ratio ( being 2.3), indicates prudence when it comes to debt. And its commanding EBIT of 10.2 times its interest expense, implies the debt load is as light as a peacock feather. Also relevant is that Ciech has grown its EBIT by a very respectable 30% in the last year, thus enhancing its ability to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Ciech can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Ciech created free cash flow amounting to 15% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

While Ciech's level of total liabilities has us nervous. To wit both its EBIT growth rate and interest cover were encouraging signs. Taking the abovementioned factors together we do think Ciech's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Ciech , and understanding them should be part of your investment process.

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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