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. Importantly, Zaklady Azotowe Pulawy S.A. (WSE:ZAP) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Zaklady Azotowe Pulawy's Debt?
As you can see below, Zaklady Azotowe Pulawy had zł49.8m of debt at June 2020, down from zł80.7m a year prior. But it also has zł653.3m in cash to offset that, meaning it has zł603.5m net cash.
A Look At Zaklady Azotowe Pulawy's Liabilities
Zooming in on the latest balance sheet data, we can see that Zaklady Azotowe Pulawy had liabilities of zł993.3m due within 12 months and liabilities of zł579.3m due beyond that. On the other hand, it had cash of zł653.3m and zł477.2m worth of receivables due within a year. So it has liabilities totalling zł442.1m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Zaklady Azotowe Pulawy has a market capitalization of zł1.53b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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.
Also positive, Zaklady Azotowe Pulawy grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. 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.
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. Looking at the most recent three years, Zaklady Azotowe Pulawy recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Although Zaklady Azotowe Pulawy's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of zł603.5m. And it impressed us with its EBIT growth of 20% over the last year. So we don't have any problem with Zaklady Azotowe Pulawy's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Zaklady Azotowe Pulawy has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
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.
If you decide to trade Zaklady Azotowe Pulawy, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.