Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu doesn’t care when he says, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital ”. So it seems like smart money knows that debt – which is usually linked to bankruptcies – is a very important factor when you assess the risk of a business. Like many other companies Stalprodukt SA (WSE: STP) uses debt. But should shareholders be worried about its use of debt?

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. While it’s not too common, we often see indebted companies continually diluting shareholders because lenders are forcing them to raise capital at a difficult price. Of course, many companies use debt to finance growth without any negative consequences. When we think of a business’s use of debt, we first look at cash flow and debt together.

Discover our latest analyzes for Stalprodukt

What is Stalprodukt’s net debt?

The image below, which you can click for more details, shows that Stalprodukt had a debt of 110.3 million zł at the end of December 2020, a reduction of 175.8 million zł over one year. But on the other hand, he also has 549.4 million zł in cash, which leads to a net cash position of 439.1 million zł.

How strong is Stalprodukt’s balance sheet?

According to the latest published balance sheet, Stalprodukt had debts of 698.5 million zł due within 12 months and debts of 761.3 million zł beyond 12 months. In return for these obligations, she had cash of 549.4 million zł as well as debts valued at 549.5 million zł with a 12-month maturity. Its liabilities therefore exceed the sum of its cash and (short-term) receivables by 360.9 million zł.

Considering that the listed Stalprodukt shares are worth a total of 1.84 billion zł, it seems unlikely that this level of liabilities is a major threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward. Despite his notable commitments, Stalprodukt has a clean cash flow, so it’s fair to say that he doesn’t have a heavy debt!

But the flip side is that Stalprodukt has seen its EBIT drop 7.6% over the past year. If profits continue to decline at this rate, the business may find it increasingly difficult to manage debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Stalprodukt’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.

Finally, while the tax authorities love accounting profits, lenders only accept cash. Although Stalprodukt has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it’s building (or erodes) that cash balance. . Over the past three years, Stalprodukt has recorded free cash flow of 48% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.

To summarize

Although Stalprodukt has more liabilities than liquid assets, it also has a net cash position of 439.1 million zł. We are therefore not concerned about the use of debt by Stalprodukt. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example – Stalprodukt a 1 warning sign we think you should be aware of this.

At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.

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