Does Izostal (WSE: IZS) have a healthy balance sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” It is only natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. Like many other companies Izostal SA (WSE: IZS) uses debt. But does this debt worry shareholders?

Why Does Debt Bring Risk?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company can’t meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a business’s debt levels is to consider its cash flow and debt together.

See our latest analysis for Izostal

How much debt does Izostal have?

You can click on the graph below for historical figures, but it shows that Izostal had a debt of Z72.3million in September 2021, up from Z91.9million a year earlier. However, because it has a cash reserve of Z21.0million, its net debt is less, at around Z51.2million.

A look at Izostal’s responsibilities

According to the last published balance sheet, Izostal had a liability of Z 275.1 million due within 12 months and a liability of Z 40.6 million due beyond 12 months. In compensation for these obligations, he had cash of Z 21.0 million as well as receivables valued at Z 169.8 million due within 12 months. It therefore has a liability totaling Z 124.8 million more than its cash and short-term receivables combined.

When you consider that this deficit exceeds the market cap of the company by Z100.5million, you may well be inclined to take a close look at 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.

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Izostal’s net debt / EBITDA ratio of around 1.8 suggests only a moderate use of debt. And its EBIT of 1,000 times its interest costs, means the debt load is as light as a peacock feather. Unfortunately, Izostal’s EBIT actually fell 3.5% last year. If this earnings trend continues, its debt load will rise like the heart of a polar bear watching its only cub. There is no doubt that we learn the most about debt from the balance sheet. But it is Izostal’s profits that will influence the balance sheet in the future. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.

Finally, a business can only repay its debts with hard cash, not with accounting profits. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Izostal has recorded free cash flow of 26% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.

Our point of view

We would go so far as to say that Izostal’s level of total liabilities was disappointing. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. Once we consider all of the above factors together it seems to us that Izostal’s debt makes it a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. When analyzing debt levels, the balance sheet is the obvious place to start. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you need to know the 2 warning signs we spotted with Izostal.

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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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 any stock 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 any of the stocks mentioned.