Warren Buffett said: “Volatility is far from synonymous with risk”. It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies Ciech SA (WSE: CIE) uses debt. But does this debt worry shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
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What is Ciech’s net debt?
As you can see below, at the end of December 2020, Ciech had a debt of Z 1.97 billion, up from Z 1.70 billion a year ago. Click on the image for more details. However, he also had Z445.2million in cash, so his net debt is Z1.53 billion.
Is Ciech’s balance sheet healthy?
The latest balance sheet data shows Ciech had a liability of Z 3.19 billion due within one year, and a liability of Z 401.1 million due thereafter. On the other hand, he had cash of Z 445.2 million and Z 477.7 million of receivables due within one year. Thus, its liabilities total 2.67 billion z more than the combination of its cash and short-term receivables.
When you consider that this deficit exceeds the company’s market capitalization zł2.21b, you may well be inclined to carefully review the balance sheet. Hypothetically, extremely high dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt compared to EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Ciech’s debt is 2.7 times its EBITDA, and its EBIT covers its interest charges 4.6 times more. This suggests that while debt levels are significant, we would stop calling them problematic. Unfortunately, Ciech’s EBIT has fallen 16% over the past four quarters. If incomes continue to decline at this rate, it will be more difficult to manage debt than taking three kids under 5 to a fancy pants restaurant. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Ciech can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. In the last three years, Ciech has recorded negative free cash flow, in total. Debt is much riskier for companies with unreliable free cash flow, so shareholders should hope that past spending will produce free cash flow in the future.
Our point of view
At first glance, Ciech’s conversion of EBIT to free cash flow left us hesitant about the stock, and its EBIT growth rate was no more attractive than the single empty restaurant on the busiest night. of the year. But at least its interest coverage isn’t that bad. After looking at the data points discussed, we believe Ciech has too much debt. While some investors enjoy this kind of risky game, it is certainly not our cup of tea. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. We have identified 2 warning signs with Ciech and understanding them should be part of your investment process.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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