Here's Why TAURON Polska Energia (WSE:TPE) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that TAURON Polska Energia S.A. (WSE:TPE) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for TAURON Polska Energia

What Is TAURON Polska Energia's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 TAURON Polska Energia had zł14.7b of debt, an increase on zł14.0b, over one year. However, because it has a cash reserve of zł1.99b, its net debt is less, at about zł12.7b.

How Healthy Is TAURON Polska Energia's Balance Sheet?

According to the last reported balance sheet, TAURON Polska Energia had liabilities of zł12.9b due within 12 months, and liabilities of zł17.4b due beyond 12 months. Offsetting these obligations, it had cash of zł1.99b as well as receivables valued at zł5.50b due within 12 months. So its liabilities total zł22.8b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the zł6.69b 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. At the end of the day, TAURON Polska Energia would probably need a major re-capitalization if its creditors were to demand repayment.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

TAURON Polska Energia has net debt worth 2.2 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.6 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably, TAURON Polska Energia's EBIT launched higher than Elon Musk, gaining a whopping 247% on last year. 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 TAURON Polska Energia'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 company can only pay off debt with cold hard cash, not accounting profits. 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, TAURON Polska Energia's free cash flow amounted to 31% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

TAURON Polska Energia's level of total liabilities and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. We should also note that Electric Utilities industry companies like TAURON Polska Energia commonly do use debt without problems. When we consider all the factors discussed, it seems to us that TAURON Polska Energia is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with TAURON Polska Energia .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.