Trans Polonia (WSE:TRN) Seems To Use Debt Quite Sensibly

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 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. As with many other companies Trans Polonia S.A. (WSE:TRN) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Trans Polonia

What Is Trans Polonia's Net Debt?

As you can see below, Trans Polonia had zł36.6m of debt at September 2020, down from zł44.0m a year prior. But on the other hand it also has zł59.7m in cash, leading to a zł23.0m net cash position.

A Look At Trans Polonia's Liabilities

We can see from the most recent balance sheet that Trans Polonia had liabilities of zł66.4m falling due within a year, and liabilities of zł86.8m due beyond that. Offsetting this, it had zł59.7m in cash and zł59.2m in receivables that were due within 12 months. So its liabilities total zł34.3m more than the combination of its cash and short-term receivables.

Trans Polonia has a market capitalization of zł74.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Trans Polonia also has more cash than debt, so we're pretty confident it can manage its debt safely.

Sadly, Trans Polonia's EBIT actually dropped 3.9% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Trans Polonia's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Trans Polonia may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Trans Polonia actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Trans Polonia does have more liabilities than liquid assets, it also has net cash of zł23.0m. And it impressed us with free cash flow of zł37m, being 158% of its EBIT. So we are not troubled with Trans Polonia's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with Trans Polonia .

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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