Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP (WSE:KMP) Could Easily Take On More Debt

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 Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP S.A. (WSE:KMP) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP

What Is Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP's Debt?

As you can see below, Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP had zł5.74m of debt at September 2020, down from zł11.2m a year prior. However, it also had zł474.0k in cash, and so its net debt is zł5.27m.

How Strong Is Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP's Balance Sheet?

We can see from the most recent balance sheet that Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP had liabilities of zł21.7m falling due within a year, and liabilities of zł15.0m due beyond that. Offsetting this, it had zł474.0k in cash and zł20.3m in receivables that were due within 12 months. So it has liabilities totalling zł15.9m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP is worth zł49.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP has net debt of just 0.34 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.0 times, which is more than adequate. Even more impressive was the fact that Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP grew its EBIT by 174% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP's earnings that will influence how the balance sheet holds up in the future. 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. Over the last three years, Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP is showing 4 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. 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.
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