These 4 Measures Indicate That Fabryka Farb i Lakierów Sniezka (WSE:SKA) Is Using Debt Reasonably Well

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 Fabryka Farb i Lakierów Sniezka SA (WSE:SKA) makes use of debt. But should shareholders be worried about its use of debt?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Fabryka Farb i Lakierów Sniezka

What Is Fabryka Farb i Lakierów Sniezka's Net Debt?

As you can see below, at the end of September 2020, Fabryka Farb i Lakierów Sniezka had zł225.0m of debt, up from zł204.4m a year ago. Click the image for more detail. However, it also had zł36.9m in cash, and so its net debt is zł188.1m.

A Look At Fabryka Farb i Lakierów Sniezka's Liabilities

The latest balance sheet data shows that Fabryka Farb i Lakierów Sniezka had liabilities of zł338.9m due within a year, and liabilities of zł87.6m falling due after that. Offsetting these obligations, it had cash of zł36.9m as well as receivables valued at zł153.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł236.3m.

Fabryka Farb i Lakierów Sniezka has a market capitalization of zł1.15b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Fabryka Farb i Lakierów Sniezka has a low net debt to EBITDA ratio of only 1.4. And its EBIT easily covers its interest expense, being 75.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that Fabryka Farb i Lakierów Sniezka grew its EBIT by 18% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fabryka Farb i Lakierów Sniezka will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Fabryka Farb i Lakierów Sniezka recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Fabryka Farb i Lakierów Sniezka's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. All these things considered, it appears that Fabryka Farb i Lakierów Sniezka can comfortably handle its current debt levels. 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. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Fabryka Farb i Lakierów Sniezka you should know about.

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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