Zaklady Magnezytowe ROPCZYCE (WSE:RPC) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Zaklady Magnezytowe ROPCZYCE S.A. (WSE:RPC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zaklady Magnezytowe ROPCZYCE

What Is Zaklady Magnezytowe ROPCZYCE's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zaklady Magnezytowe ROPCZYCE had zł50.1m of debt in September 2020, down from zł75.3m, one year before. However, it does have zł36.0m in cash offsetting this, leading to net debt of about zł14.1m.

A Look At Zaklady Magnezytowe ROPCZYCE's Liabilities

We can see from the most recent balance sheet that Zaklady Magnezytowe ROPCZYCE had liabilities of zł86.9m falling due within a year, and liabilities of zł53.8m due beyond that. Offsetting these obligations, it had cash of zł36.0m as well as receivables valued at zł72.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł31.9m.

While this might seem like a lot, it is not so bad since Zaklady Magnezytowe ROPCZYCE has a market capitalization of zł136.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Zaklady Magnezytowe ROPCZYCE's net debt is only 0.37 times its EBITDA. And its EBIT covers its interest expense a whopping 29.1 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that Zaklady Magnezytowe ROPCZYCE has seen its EBIT plunge 10% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is Zaklady Magnezytowe ROPCZYCE'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.

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. During the last three years, Zaklady Magnezytowe ROPCZYCE produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Zaklady Magnezytowe ROPCZYCE's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its EBIT growth rate. All these things considered, it appears that Zaklady Magnezytowe ROPCZYCE can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Zaklady Magnezytowe ROPCZYCE , and understanding them should be part of your investment process.

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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