Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Energoinstal AG (WSE:ENI) uses debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
Discover our latest analysis for Energoinstal
What is Energoinstal’s net debt?
You can click on the graph below for historical figures, but it shows that as of September 2021, Energoinstal had zł18.1 million in debt, an increase of zł6.18 million, year-on-year. On the other hand, it has 8.66 million zł of liquid assets, which results in a net debt of approximately 9.47 million zł.
How healthy is Energoinstal’s balance sheet?
We can see from the most recent balance sheet that Energoinstal had liabilities of 52.1 million zł due in one year, and liabilities of 15.7 million zł due beyond. In return, he had 8.66 million zł in cash and 43.1 million zł in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by 16.1 million zł.
This deficit is considerable compared to its market capitalization of zł 19.4 million, so it suggests that shareholders monitor the use of debt by Energoinstal. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Even though Energoinstal’s debt is only 1.8, its interest coverage is really very low at 0.73. The main reason for this is that it has such high depreciation and amortization. These fees may be non-monetary, so they could be excluded when it comes to repaying the debt. But accounting fees are there for a reason: some assets seem to lose value. Regardless, there is no doubt that the stock uses significant leverage. Importantly, Energoinstal’s EBIT has fallen by 74% over the last twelve months. If this decline continues, it will be more difficult to repay debts than to sell foie gras at a vegan convention. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Energoinstal will need income to repay this debt. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
Finally, a company can only repay its debts with cash, not book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Energoinstal has burned a lot of money. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
To be frank, Energoinstal’s conversion of EBIT to free cash flow and its history of (non-)growth in its EBIT makes us rather uncomfortable with its level of leverage. That said, its ability to manage its debt, based on its EBITDA, is not so worrying. Considering all the above factors, it seems that Energoinstal has too much debt. While some investors like this kind of risky play, it’s definitely not our cup of tea. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Energoinstal (2 of which don’t really suit us!) that you should know.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.