Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ 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 Torpol S.A. (WSE:TOR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Torpol Carry?
You can click the graphic below for the historical numbers, but it shows that Torpol had zł63.9m of debt in March 2021, down from zł69.4m, one year before. However, its balance sheet shows it holds zł476.3m in cash, so it actually has zł412.5m net cash.
How Healthy Is Torpol’s Balance Sheet?
We can see from the most recent balance sheet that Torpol had liabilities of zł681.9m falling due within a year, and liabilities of zł85.7m due beyond that. On the other hand, it had cash of zł476.3m and zł256.9m worth of receivables due within a year. So it has liabilities totalling zł34.4m more than its cash and near-term receivables, combined.
Since publicly traded Torpol shares are worth a total of zł357.9m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Torpol boasts net cash, so it’s fair to say it does not have a heavy debt load!
On top of that, Torpol grew its EBIT by 34% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Torpol’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Torpol has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Torpol actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
We could understand if investors are concerned about Torpol’s liabilities, but we can be reassured by the fact it has has net cash of zł412.5m. The cherry on top was that in converted 276% of that EBIT to free cash flow, bringing in zł235m. So is Torpol’s debt a risk? It doesn’t seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. We’ve identified 3 warning signs with Torpol (at least 1 which is significant) , and understanding them should be part of your investment process.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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Read More:Is Torpol (WSE:TOR) A Risky Investment?