Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Hamilton Thorne Ltd. (CVE:HTL) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Hamilton Thorne's Net Debt?
As you can see below, Hamilton Thorne had US$9.32m of debt at March 2019, down from US$10.8m a year prior. But it also has US$14.4m in cash to offset that, meaning it has US$5.13m net cash.
How Healthy Is Hamilton Thorne's Balance Sheet?
The latest balance sheet data shows that Hamilton Thorne had liabilities of US$8.88m due within a year, and liabilities of US$9.64m falling due after that. Offsetting this, it had US$14.4m in cash and US$3.04m in receivables that were due within 12 months. So its liabilities total US$1.04m more than the combination of its cash and short-term receivables.
This state of affairs indicates that Hamilton Thorne's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$107.7m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Hamilton Thorne also has more cash than debt, so we're pretty confident it can manage its debt safely.
Notably Hamilton Thorne's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hamilton Thorne's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hamilton Thorne 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. During the last three years, Hamilton Thorne produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
We could understand if investors are concerned about Hamilton Thorne's liabilities, but we can be reassured by the fact it has has net cash of US$5.1m. And it impressed us with free cash flow of US$3.8m, being 76% of its EBIT. So we don't have any problem with Hamilton Thorne's use of debt. We'd be motivated to research the stock further if we found out that Hamilton Thorne insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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