The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Breville Group Limited (ASX:BRG) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Breville Group's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Breville Group had debt of AU$47.3m, up from AU$45.3m in one year. But on the other hand it also has AU$57.1m in cash, leading to a AU$9.85m net cash position.
A Look At Breville Group's Liabilities
According to the last reported balance sheet, Breville Group had liabilities of AU$143.4m due within 12 months, and liabilities of AU$56.0m due beyond 12 months. On the other hand, it had cash of AU$57.1m and AU$154.8m worth of receivables due within a year. So it actually has AU$12.5m more liquid assets than total liabilities.
Having regard to Breville Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the AU$2.34b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Breville Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Breville Group grew its EBIT at 11% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Breville Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Breville Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Breville Group's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While we empathize with investors who find debt concerning, you should keep in mind that Breville Group has net cash of AU$9.85m, as well as more liquid assets than liabilities. And it also grew its EBIT by 11% over the last year. So we don't think Breville Group's use of debt is risky. 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. For example, we've discovered 1 warning sign for Breville Group that you should be aware of before investing here.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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