PGE Polska Grupa Energetyczna (WSE:PGE) Takes On Some Risk With Its Use Of 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. Importantly, PGE Polska Grupa Energetyczna S.A. (WSE:PGE) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

See our latest analysis for PGE Polska Grupa Energetyczna

What Is PGE Polska Grupa Energetyczna's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 PGE Polska Grupa Energetyczna had zł12.9b of debt, an increase on zł8.26b, over one year. However, it does have zł13.9b in cash offsetting this, leading to net cash of zł1.01b.

A Look At PGE Polska Grupa Energetyczna's Liabilities

We can see from the most recent balance sheet that PGE Polska Grupa Energetyczna had liabilities of zł35.5b falling due within a year, and liabilities of zł21.6b due beyond that. Offsetting these obligations, it had cash of zł13.9b as well as receivables valued at zł9.76b due within 12 months. So it has liabilities totalling zł33.4b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the zł17.9b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, PGE Polska Grupa Energetyczna would probably need a major re-capitalization if its creditors were to demand repayment. Given that PGE Polska Grupa Energetyczna has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

It is just as well that PGE Polska Grupa Energetyczna's load is not too heavy, because its EBIT was down 34% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. PGE Polska Grupa Energetyczna 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. During the last three years, PGE Polska Grupa Energetyczna produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While PGE Polska Grupa Energetyczna does have more liabilities than liquid assets, it also has net cash of zł1.01b. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in zł3.5b. So while PGE Polska Grupa Energetyczna does not have a great balance sheet, it's certainly not too bad. 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. Be aware that PGE Polska Grupa Energetyczna is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.