Is TAURON Polska Energia (WSE:TPE) A Risky Investment?

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 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. We note that TAURON Polska Energia S.A. (WSE:TPE) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for TAURON Polska Energia

How Much Debt Does TAURON Polska Energia Carry?

The image below, which you can click on for greater detail, shows that at March 2022 TAURON Polska Energia had debt of zł14.6b, up from zł13.2b in one year. However, because it has a cash reserve of zł1.27b, its net debt is less, at about zł13.3b.

How Strong Is TAURON Polska Energia's Balance Sheet?

We can see from the most recent balance sheet that TAURON Polska Energia had liabilities of zł10.4b falling due within a year, and liabilities of zł15.2b due beyond that. Offsetting this, it had zł1.27b in cash and zł5.04b in receivables that were due within 12 months. So its liabilities total zł19.3b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the zł6.08b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, TAURON Polska Energia 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). 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 a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 6.1 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Shareholders should be aware that TAURON Polska Energia's EBIT was down 26% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if TAURON Polska Energia can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 created free cash flow amounting to 3.2% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On the face of it, TAURON Polska Energia's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least its interest cover is not so bad. We should also note that Electric Utilities industry companies like TAURON Polska Energia commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like TAURON Polska Energia has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for TAURON Polska Energia that you should be aware of before investing here.

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.