Does Zaklady Azotowe Pulawy (WSE:ZAP) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Zaklady Azotowe Pulawy S.A. (WSE:ZAP) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Zaklady Azotowe Pulawy

What Is Zaklady Azotowe Pulawy's Net Debt?

The image below, which you can click on for greater detail, shows that Zaklady Azotowe Pulawy had debt of zł44.5m at the end of September 2020, a reduction from zł82.7m over a year. However, its balance sheet shows it holds zł598.2m in cash, so it actually has zł553.7m net cash.

A Look At Zaklady Azotowe Pulawy's Liabilities

According to the last reported balance sheet, Zaklady Azotowe Pulawy had liabilities of zł993.4m due within 12 months, and liabilities of zł573.3m due beyond 12 months. Offsetting this, it had zł598.2m in cash and zł414.6m in receivables that were due within 12 months. So its liabilities total zł554.0m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Zaklady Azotowe Pulawy has a market capitalization of zł1.86b, 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. Despite its noteworthy liabilities, Zaklady Azotowe Pulawy boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Zaklady Azotowe Pulawy's load is not too heavy, because its EBIT was down 21% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Zaklady Azotowe Pulawy's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Zaklady Azotowe Pulawy 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, Zaklady Azotowe Pulawy recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While Zaklady Azotowe Pulawy does have more liabilities than liquid assets, it also has net cash of zł553.7m. So although we see some areas for improvement, we're not too worried about Zaklady Azotowe Pulawy's 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. Case in point: We've spotted 2 warning signs for Zaklady Azotowe Pulawy you should be aware of, and 1 of them is a bit unpleasant.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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