Is Zaklady Azotowe Pulawy (WSE:ZAP) A Risky Investment?

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.' 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 Zaklady Azotowe Pulawy S.A. (WSE:ZAP) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Azotowe Pulawy

What Is Zaklady Azotowe Pulawy's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Zaklady Azotowe Pulawy had zł98.9m of debt, an increase on zł71.1m, over one year. But it also has zł191.7m in cash to offset that, meaning it has zł92.7m net cash.

How Strong Is Zaklady Azotowe Pulawy's Balance Sheet?

The latest balance sheet data shows that Zaklady Azotowe Pulawy had liabilities of zł2.16b due within a year, and liabilities of zł599.3m falling due after that. On the other hand, it had cash of zł191.7m and zł1.42b worth of receivables due within a year. So it has liabilities totalling zł1.14b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of zł1.52b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Zaklady Azotowe Pulawy also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Zaklady Azotowe Pulawy's saving grace is its low debt levels, because its EBIT has tanked 52% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Zaklady Azotowe Pulawy 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. Over the last three years, Zaklady Azotowe Pulawy actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Zaklady Azotowe Pulawy does have more liabilities than liquid assets, it also has net cash of zł92.7m. And it impressed us with free cash flow of zł742m, being 131% of its EBIT. So we don't have any problem with Zaklady Azotowe Pulawy's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Zaklady Azotowe Pulawy is showing 2 warning signs in our investment analysis , and 1 of those is significant...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.