Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that CSP International Fashion Group S.p.A. (BIT:CSP) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is CSP International Fashion Group's Net Debt?
As you can see below, CSP International Fashion Group had €15.5m of debt at June 2019, down from €21.6m a year prior. However, it does have €19.3m in cash offsetting this, leading to net cash of €3.73m.
How Strong Is CSP International Fashion Group's Balance Sheet?
The latest balance sheet data shows that CSP International Fashion Group had liabilities of €37.7m due within a year, and liabilities of €22.9m falling due after that. Offsetting this, it had €19.3m in cash and €17.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €23.7m.
Given this deficit is actually higher than the company's market capitalization of €19.0m, we think shareholders really should watch CSP International Fashion Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Given that CSP International Fashion Group has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since CSP International Fashion Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year CSP International Fashion Group had negative earnings before interest and tax, and actually shrunk its revenue by 8.2%, to €110m. We would much prefer see growth.
So How Risky Is CSP International Fashion Group?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months CSP International Fashion Group lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of €1.0m and booked a €13m accounting loss. But the saving grace is the €3.73m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. For riskier companies like CSP International Fashion Group I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Thank you for reading.