Stalprodukt (WSE:STP) Could Easily Take On More Debt

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.' 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. We can see that Stalprodukt S.A. (WSE:STP) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Stalprodukt

What Is Stalprodukt's Net Debt?

As you can see below, Stalprodukt had zł104.5m of debt at December 2021, down from zł118.5m a year prior. But it also has zł603.9m in cash to offset that, meaning it has zł499.4m net cash.

How Healthy Is Stalprodukt's Balance Sheet?

We can see from the most recent balance sheet that Stalprodukt had liabilities of zł925.4m falling due within a year, and liabilities of zł559.1m due beyond that. Offsetting these obligations, it had cash of zł603.9m as well as receivables valued at zł854.6m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that Stalprodukt's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the zł1.64b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Stalprodukt boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Stalprodukt grew its EBIT by 224% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Stalprodukt may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Stalprodukt recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

We could understand if investors are concerned about Stalprodukt's liabilities, but we can be reassured by the fact it has has net cash of zł499.4m. And it impressed us with its EBIT growth of 224% over the last year. So is Stalprodukt's debt a risk? It doesn't seem so to us. 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 1 warning sign with Stalprodukt , 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.