We Think PGE Polska Grupa Energetyczna (WSE:PGE) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies PGE Polska Grupa Energetyczna S.A. (WSE:PGE) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for PGE Polska Grupa Energetyczna

What Is PGE Polska Grupa Energetyczna's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2023 PGE Polska Grupa Energetyczna had debt of zł13.4b, up from zł9.07b in one year. However, because it has a cash reserve of zł9.62b, its net debt is less, at about zł3.73b.

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

According to the last reported balance sheet, PGE Polska Grupa Energetyczna had liabilities of zł45.0b due within 12 months, and liabilities of zł19.6b due beyond 12 months. On the other hand, it had cash of zł9.62b and zł12.7b worth of receivables due within a year. So its liabilities total zł42.3b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the zł19.1b 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'd watch its balance sheet closely, without a doubt. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

PGE Polska Grupa Energetyczna has a low debt to EBITDA ratio of only 0.41. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. On the other hand, PGE Polska Grupa Energetyczna saw its EBIT drop by 8.8% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, PGE Polska Grupa Energetyczna's free cash flow amounted to 43% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over PGE Polska Grupa Energetyczna's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We should also note that Electric Utilities industry companies like PGE Polska Grupa Energetyczna commonly do use debt without problems. Once we consider all the factors above, together, it seems to us that PGE Polska Grupa Energetyczna's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for PGE Polska Grupa Energetyczna (of which 1 is concerning!) 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.