Is Stalprodukt (WSE:STP) Using Too Much Debt?

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. As with many other companies Stalprodukt S.A. (WSE:STP) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Stalprodukt

What Is Stalprodukt's Net Debt?

The image below, which you can click on for greater detail, shows that Stalprodukt had debt of zł110.3m at the end of December 2020, a reduction from zł175.8m over a year. But on the other hand it also has zł549.4m in cash, leading to a zł439.1m net cash position.

How Strong Is Stalprodukt's Balance Sheet?

According to the last reported balance sheet, Stalprodukt had liabilities of zł698.5m due within 12 months, and liabilities of zł761.3m due beyond 12 months. Offsetting these obligations, it had cash of zł549.4m as well as receivables valued at zł549.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł360.9m.

Since publicly traded Stalprodukt shares are worth a total of zł1.84b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Stalprodukt boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Stalprodukt saw its EBIT decline by 7.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Stalprodukt's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Stalprodukt has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Stalprodukt recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While Stalprodukt does have more liabilities than liquid assets, it also has net cash of zł439.1m. So we are not troubled with Stalprodukt's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Stalprodukt has 1 warning sign we think you should be aware of.

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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