IMPOL SEVAL Valjaonica Aluminijuma a.d (BELEX:IMPL) Use Of Debt Could Be Considered Risky

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.' 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 IMPOL SEVAL Valjaonica Aluminijuma a.d. (BELEX:IMPL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

See our latest analysis for IMPOL SEVAL Valjaonica Aluminijuma a.d

What Is IMPOL SEVAL Valjaonica Aluminijuma a.d's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 IMPOL SEVAL Valjaonica Aluminijuma a.d had дин3.26b of debt, an increase on дин2.57b, over one year. However, it does have дин387.8m in cash offsetting this, leading to net debt of about дин2.87b.

How Strong Is IMPOL SEVAL Valjaonica Aluminijuma a.d's Balance Sheet?

The latest balance sheet data shows that IMPOL SEVAL Valjaonica Aluminijuma a.d had liabilities of дин4.72b due within a year, and liabilities of дин2.14b falling due after that. On the other hand, it had cash of дин387.8m and дин1.60b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by дин4.87b.

Given this deficit is actually higher than the company's market capitalization of дин3.25b, we think shareholders really should watch IMPOL SEVAL Valjaonica Aluminijuma a.d's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.41 times and a disturbingly high net debt to EBITDA ratio of 7.0 hit our confidence in IMPOL SEVAL Valjaonica Aluminijuma a.d like a one-two punch to the gut. The debt burden here is substantial. Worse, IMPOL SEVAL Valjaonica Aluminijuma a.d's EBIT was down 96% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since IMPOL SEVAL Valjaonica Aluminijuma a.d will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, IMPOL SEVAL Valjaonica Aluminijuma a.d 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

To be frank both IMPOL SEVAL Valjaonica Aluminijuma a.d's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And even its net debt to EBITDA fails to inspire much confidence. It looks to us like IMPOL SEVAL Valjaonica Aluminijuma a.d carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. To that end, you should learn about the 5 warning signs we've spotted with IMPOL SEVAL Valjaonica Aluminijuma a.d (including 2 which are potentially serious) .

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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