We Think WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji (WSE:WOD) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji S.A. (WSE:WOD) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji

What Is WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji's Net Debt?

As you can see below, at the end of March 2024, WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji had zł15.9m of debt, up from zł14.0m a year ago. Click the image for more detail. However, it does have zł8.75m in cash offsetting this, leading to net debt of about zł7.13m.

How Healthy Is WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji's Balance Sheet?

We can see from the most recent balance sheet that WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji had liabilities of zł7.97m falling due within a year, and liabilities of zł70.4m due beyond that. On the other hand, it had cash of zł8.75m and zł2.67m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł67.0m.

This deficit casts a shadow over the zł32.0m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji has a low debt to EBITDA ratio of only 0.67. 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. In addition to that, we're happy to report that WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji has boosted its EBIT by 37%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We feel some trepidation about WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. We should also note that Water Utilities industry companies like WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji commonly do use debt without problems. When we consider all the factors discussed, it seems to us that WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for WODKAN Przedsiebiorstwo Wodociagów i Kanalizacji (2 are a bit unpleasant!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.