Is Polenergia (WSE: PEP) getting too much debt?

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Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “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 involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We can see that Polenergie SA (WSE: PEP) uses debt in its business. But the most important question is: what risk does this debt create?

What risk does debt entail?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first consider both liquidity and debt levels.

See our latest review for Polenergia

What is Polenergia’s debt?

You can click on the graph below for historical figures, but it shows that as of June 2021 Polenergia had a debt of Z 1.19 billion, an increase from Z 791.1 million, on a year. However, his balance sheet shows that he holds Z 1.36 billion in cash, so he actually has a net cash position of Z 166.1 million.

WSE: PEP History of debt on equity November 8, 2021

Is Polenergia’s track record healthy?

According to the latest published balance sheet, Polenergia had liabilities of Z 1.21 billion due within 12 months and liabilities of Z 1.42 billion due beyond 12 months. In compensation for these obligations, he had cash of Z 1.36 billion as well as receivables valued at Z 399.1 million due within 12 months. It therefore has a liability totaling Z 873.6 million more than its cash and short-term receivables combined.

Polenergia has a market capitalization of Z 4.24 billion, so it could most likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt. While she has some liabilities to note, Polenergia also has more cash than debt, so we’re pretty confident that she can handle her debt safely.

The good news is that Polenergia increased its EBIT by 3.6% year over year, which should allay concerns about debt repayment. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Polenergia’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a business can only pay off its debts with hard cash, not with book profits. Polenergia may have net cash on the balance sheet, but it is always interesting to see the extent to which the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. In the last three years, Polenergia has published free cash flow of 4.4% of its EBIT, which is really quite low. This low level of cash conversion undermines its ability to manage and repay its debts.

In summary

Although Polenergia’s balance sheet is not particularly strong, due to total liabilities it is clearly positive to see that it has a net cash position of Z 166.1 million. On top of that, it has increased its EBIT by 3.6% over the past twelve months. We therefore have no problem with the use of the debt by Polenergia. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 4 warning signs for Polenergia you need to be aware of this, and 3 of them cannot be ignored.

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.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.

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