Is Zaklady Azotowe Pulawy (WSE:ZAP) 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. We note that Zaklady Azotowe Pulawy S.A. (WSE:ZAP) does have debt on its balance sheet. 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. 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.

Check out our latest analysis for Zaklady Azotowe Pulawy

What Is Zaklady Azotowe Pulawy's Debt?

The image below, which you can click on for greater detail, shows that Zaklady Azotowe Pulawy had debt of zł152.0m at the end of September 2024, a reduction from zł232.2m over a year. However, it does have zł139.9m in cash offsetting this, leading to net debt of about zł12.1m.

How Strong Is Zaklady Azotowe Pulawy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zaklady Azotowe Pulawy had liabilities of zł3.03b due within 12 months and liabilities of zł483.8m due beyond that. On the other hand, it had cash of zł139.9m and zł392.8m worth of receivables due within a year. So its liabilities total zł2.98b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the zł776.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Zaklady Azotowe Pulawy would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Zaklady Azotowe Pulawy will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Zaklady Azotowe Pulawy made a loss at the EBIT level, and saw its revenue drop to zł3.6b, which is a fall of 32%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Zaklady Azotowe Pulawy's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping zł415m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it lost zł447m in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Zaklady Azotowe Pulawy you should know about.

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.