We Think Orange Polska (WSE:OPL) Can Stay On Top Of Its Debt

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.' 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. Importantly, Orange Polska S.A. (WSE:OPL) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, 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.

See our latest analysis for Orange Polska

What Is Orange Polska's Net Debt?

The chart below, which you can click on for greater detail, shows that Orange Polska had zł5.04b in debt in December 2022; about the same as the year before. On the flip side, it has zł1.06b in cash leading to net debt of about zł3.99b.

How Healthy Is Orange Polska's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Orange Polska had liabilities of zł5.25b due within 12 months and liabilities of zł8.07b due beyond that. Offsetting this, it had zł1.06b in cash and zł2.12b in receivables that were due within 12 months. So it has liabilities totalling zł10.1b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of zł8.97b, we think shareholders really should watch Orange Polska'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.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Orange Polska's low debt to EBITDA ratio of 1.4 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.3 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. It is well worth noting that Orange Polska's EBIT shot up like bamboo after rain, gaining 42% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Orange Polska can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Orange Polska 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

Both Orange Polska's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. But truth be told its level of total liabilities had us nibbling our nails. Considering this range of data points, we think Orange Polska is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Orange Polska is showing 2 warning signs in our investment analysis , 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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.