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. Importantly, Cyfrowy Polsat S.A. (WSE:CPS) does carry 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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Cyfrowy Polsat’s Debt?
The image below, which you can click on for greater detail, shows that at March 2020 Cyfrowy Polsat had debt of zł11.8b, up from zł10.7b in one year. However, it does have zł1.13b in cash offsetting this, leading to net debt of about zł10.6b.
How Strong Is Cyfrowy Polsat’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Cyfrowy Polsat had liabilities of zł5.11b due within 12 months and liabilities of zł12.9b due beyond that. Offsetting these obligations, it had cash of zł1.13b as well as receivables valued at zł2.97b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł13.9b.
This deficit is considerable relative to its market capitalization of zł17.3b, so it does suggest shareholders should keep an eye on Cyfrowy Polsat’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Cyfrowy Polsat’s debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 4.7 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. We saw Cyfrowy Polsat grow its EBIT by 8.0% in the last twelve months. That’s far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Cyfrowy Polsat’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it’s worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Cyfrowy Polsat actually produced more free cash flow than EBIT over the last three years. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
When it comes to the balance sheet, the standout positive for Cyfrowy Polsat was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren’t so heartening. For instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the factors mentioned above, we do feel a bit cautious about Cyfrowy Polsat’s use of debt. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. 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 – Cyfrowy Polsat has 2 warning signs we think you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
When trading Cyfrowy Polsat or any other investment, use the platform considered by many to be the Professional’s Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide 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 firstname.lastname@example.org.