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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.' 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, Daily Mail and General Trust plc (LON:DMGT) does carry debt. But the more important question is: how much risk is that debt creating?
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. 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. 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.
How Much Debt Does Daily Mail and General Trust Carry?
The image below, which you can click on for greater detail, shows that at September 2020 Daily Mail and General Trust had debt of UK£223.9m, up from UK£214.6m in one year. However, it does have UK£500.3m in cash offsetting this, leading to net cash of UK£276.4m.
How Strong Is Daily Mail and General Trust's Balance Sheet?
According to the last reported balance sheet, Daily Mail and General Trust had liabilities of UK£522.2m due within 12 months, and liabilities of UK£324.1m due beyond 12 months. Offsetting this, it had UK£500.3m in cash and UK£247.7m in receivables that were due within 12 months. So it has liabilities totalling UK£98.3m more than its cash and near-term receivables, combined.
Of course, Daily Mail and General Trust has a market capitalization of UK£1.95b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Daily Mail and General Trust boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Daily Mail and General Trust if management cannot prevent a repeat of the 39% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Daily Mail and General Trust 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. While Daily Mail and General Trust 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, Daily Mail and General Trust generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Daily Mail and General Trust has UK£276.4m in net cash. And it impressed us with free cash flow of UK£125m, being 90% of its EBIT. So we are not troubled with Daily Mail and General Trust's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Daily Mail and General Trust you should know about.
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.
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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