These 4 Measures Indicate That Polski Holding Nieruchomosci (WSE:PHN) Is Using Debt Extensively

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Polski Holding Nieruchomosci S.A. (WSE:PHN) does carry debt. But the more important question is: how much risk is that debt creating?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Polski Holding Nieruchomosci

What Is Polski Holding Nieruchomosci's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Polski Holding Nieruchomosci had zł812.2m of debt, an increase on zł724.0m, over one year. However, it also had zł208.5m in cash, and so its net debt is zł603.7m.

How Healthy Is Polski Holding Nieruchomosci's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Polski Holding Nieruchomosci had liabilities of zł573.6m due within 12 months and liabilities of zł1.13b due beyond that. On the other hand, it had cash of zł208.5m and zł84.2m worth of receivables due within a year. So it has liabilities totalling zł1.41b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the zł672.0m 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. At the end of the day, Polski Holding Nieruchomosci would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 2.5 times and a disturbingly high net debt to EBITDA ratio of 9.0 hit our confidence in Polski Holding Nieruchomosci like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Fortunately, Polski Holding Nieruchomosci grew its EBIT by 6.9% in the last year, slowly shrinking its debt relative to earnings. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Polski Holding Nieruchomosci's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Polski Holding Nieruchomosci actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both Polski Holding Nieruchomosci's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, we think it's fair to say that Polski Holding Nieruchomosci has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 Polski Holding Nieruchomosci is showing 2 warning signs in our investment analysis , you should know about...

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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