Is Zaklady Urzadzen Komputerowych ELZAB (WSE:ELZ) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Zaklady Urzadzen Komputerowych ELZAB S.A. (WSE:ELZ) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zaklady Urzadzen Komputerowych ELZAB

What Is Zaklady Urzadzen Komputerowych ELZAB's Debt?

As you can see below, Zaklady Urzadzen Komputerowych ELZAB had zł85.0m of debt at September 2020, down from zł90.2m a year prior. However, it does have zł11.4m in cash offsetting this, leading to net debt of about zł73.6m.

A Look At Zaklady Urzadzen Komputerowych ELZAB's Liabilities

Zooming in on the latest balance sheet data, we can see that Zaklady Urzadzen Komputerowych ELZAB had liabilities of zł88.4m due within 12 months and liabilities of zł18.5m due beyond that. Offsetting these obligations, it had cash of zł11.4m as well as receivables valued at zł43.2m due within 12 months. So it has liabilities totalling zł52.2m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Zaklady Urzadzen Komputerowych ELZAB is worth zł89.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Zaklady Urzadzen Komputerowych ELZAB's debt is 4.9 times its EBITDA, and its EBIT cover its interest expense 5.4 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably, Zaklady Urzadzen Komputerowych ELZAB made a loss at the EBIT level, last year, but improved that to positive EBIT of zł11m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Zaklady Urzadzen Komputerowych ELZAB's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Zaklady Urzadzen Komputerowych ELZAB actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On our analysis Zaklady Urzadzen Komputerowych ELZAB's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. In particular, net debt to EBITDA gives us cold feet. Looking at all this data makes us feel a little cautious about Zaklady Urzadzen Komputerowych ELZAB's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Zaklady Urzadzen Komputerowych ELZAB you should be aware of, and 2 of them shouldn't be ignored.

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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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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