Is TAURON Polska Energia (WSE:TPE) Using Too Much 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. We can see that TAURON Polska Energia S.A. (WSE:TPE) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 TAURON Polska Energia

What Is TAURON Polska Energia's Debt?

You can click the graphic below for the historical numbers, but it shows that TAURON Polska Energia had zł13.2b of debt in March 2021, down from zł14.6b, one year before. However, it does have zł1.51b in cash offsetting this, leading to net debt of about zł11.7b.

A Look At TAURON Polska Energia's Liabilities

The latest balance sheet data shows that TAURON Polska Energia had liabilities of zł8.20b due within a year, and liabilities of zł15.7b falling due after that. Offsetting this, it had zł1.51b in cash and zł3.11b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł19.3b.

The deficiency here weighs heavily on the zł6.59b 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

TAURON Polska Energia's net debt to EBITDA ratio of about 2.4 suggests only moderate use of debt. And its strong interest cover of 10.2 times, makes us even more comfortable. Notably, TAURON Polska Energia's EBIT launched higher than Elon Musk, gaining a whopping 198% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, TAURON Polska Energia burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both TAURON Polska Energia's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We should also note that Electric Utilities industry companies like TAURON Polska Energia commonly do use debt without problems. Once we consider all the factors above, together, it seems to us that TAURON Polska Energia's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. For example, we've discovered 1 warning sign 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.
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