Is Tower Investments (WSE:TOW) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Tower Investments S.A. (WSE:TOW) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Tower Investments

What Is Tower Investments's Debt?

The chart below, which you can click on for greater detail, shows that Tower Investments had zł24.8m in debt in December 2020; about the same as the year before. However, it also had zł6.60m in cash, and so its net debt is zł18.2m.

A Look At Tower Investments' Liabilities

According to the last reported balance sheet, Tower Investments had liabilities of zł28.1m due within 12 months, and liabilities of zł29.2m due beyond 12 months. Offsetting these obligations, it had cash of zł6.60m as well as receivables valued at zł7.84m due within 12 months. So its liabilities total zł42.8m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of zł31.3m, we think shareholders really should watch Tower Investments's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tower Investments will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Tower Investments made a loss at the EBIT level, and saw its revenue drop to zł19m, which is a fall of 50%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Tower Investments's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable zł5.5m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through zł2.8m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. To that end, you should learn about the 4 warning signs we've spotted with Tower Investments (including 3 which don't sit too well with us) .

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. 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.
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