PGE Polska Grupa Energetyczna (WSE:PGE) Has A Somewhat Strained Balance Sheet

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. We can see that PGE Polska Grupa Energetyczna S.A. (WSE:PGE) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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 PGE Polska Grupa Energetyczna

How Much Debt Does PGE Polska Grupa Energetyczna Carry?

As you can see below, PGE Polska Grupa Energetyczna had zł10.0b of debt at June 2024, down from zł12.9b a year prior. However, because it has a cash reserve of zł4.48b, its net debt is less, at about zł5.55b.

How Strong Is PGE Polska Grupa Energetyczna's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PGE Polska Grupa Energetyczna had liabilities of zł46.0b due within 12 months and liabilities of zł22.8b due beyond that. Offsetting these obligations, it had cash of zł4.48b as well as receivables valued at zł8.79b due within 12 months. So it has liabilities totalling zł55.6b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the zł15.5b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, PGE Polska Grupa Energetyczna would likely require a major re-capitalisation if it had to pay its creditors today.

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.

PGE Polska Grupa Energetyczna's net debt is only 0.63 times its EBITDA. And its EBIT easily covers its interest expense, being 719 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that PGE Polska Grupa Energetyczna has boosted its EBIT by 90%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PGE Polska Grupa Energetyczna'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, PGE Polska Grupa Energetyczna created free cash flow amounting to 13% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

While PGE Polska Grupa Energetyczna's level of total liabilities has us nervous. To wit both its interest cover and EBIT growth rate were encouraging signs. We should also note that Electric Utilities industry companies like PGE Polska Grupa Energetyczna commonly do use debt without problems. We think that PGE Polska Grupa Energetyczna's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Even though PGE Polska Grupa Energetyczna lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

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.