We Think PGE Polska Grupa Energetyczna (WSE:PGE) Is Taking Some Risk With 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.' 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 the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for PGE Polska Grupa Energetyczna

What Is PGE Polska Grupa Energetyczna's Debt?

You can click the graphic below for the historical numbers, but it shows that PGE Polska Grupa Energetyczna had zł7.94b of debt in December 2022, down from zł9.90b, one year before. But on the other hand it also has zł13.5b in cash, leading to a zł5.53b net cash position.

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 zł35.3b due within 12 months and liabilities of zł16.1b due beyond that. Offsetting these obligations, it had cash of zł13.5b as well as receivables valued at zł9.33b due within 12 months. So it has liabilities totalling zł28.6b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the zł15.1b 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. After all, PGE Polska Grupa Energetyczna would likely require a major re-capitalisation if it had to pay its creditors today. PGE Polska Grupa Energetyczna boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

On the other hand, PGE Polska Grupa Energetyczna's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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. 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. Over the last three years, PGE Polska Grupa Energetyczna actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While PGE Polska Grupa Energetyczna does have more liabilities than liquid assets, it also has net cash of zł5.53b. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in zł4.9b. So although we see some areas for improvement, we're not too worried about PGE Polska Grupa Energetyczna's balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for PGE Polska Grupa Energetyczna 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.