Is Zaklady Azotowe Pulawy (WSE:ZAP) Using Too Much Debt?

Warren Buffett famously said, '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. As with many other companies Zaklady Azotowe Pulawy S.A. (WSE:ZAP) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 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 Zaklady Azotowe Pulawy

What Is Zaklady Azotowe Pulawy's Debt?

As you can see below, at the end of September 2022, Zaklady Azotowe Pulawy had zł135.2m of debt, up from zł98.9m a year ago. Click the image for more detail. But on the other hand it also has zł1.13b in cash, leading to a zł996.9m net cash position.

How Strong Is Zaklady Azotowe Pulawy's Balance Sheet?

According to the last reported balance sheet, Zaklady Azotowe Pulawy had liabilities of zł2.71b due within 12 months, and liabilities of zł482.5m due beyond 12 months. Offsetting these obligations, it had cash of zł1.13b as well as receivables valued at zł503.2m due within 12 months. So it has liabilities totalling zł1.56b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of zł1.51b, we think shareholders really should watch Zaklady Azotowe Pulawy's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Zaklady Azotowe Pulawy boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Better yet, Zaklady Azotowe Pulawy grew its EBIT by 874% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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 zł996.9m. The cherry on top was that in converted 144% of that EBIT to free cash flow, bringing in zł2.0b. So we are not troubled with Zaklady Azotowe Pulawy'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. To that end, you should be aware of the 2 warning signs we've spotted with Zaklady Azotowe Pulawy .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.