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. 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 note that ReadyTech Holdings Limited (ASX:RDY) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is ReadyTech Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that ReadyTech Holdings had debt of AU$21.5m at the end of June 2019, a reduction from AU$29.8m over a year. However, because it has a cash reserve of AU$6.32m, its net debt is less, at about AU$15.2m.
How Strong Is ReadyTech Holdings's Balance Sheet?
The latest balance sheet data shows that ReadyTech Holdings had liabilities of AU$16.0m due within a year, and liabilities of AU$24.5m falling due after that. Offsetting this, it had AU$6.32m in cash and AU$3.47m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$30.7m.
Of course, ReadyTech Holdings has a market capitalization of AU$154.4m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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 ReadyTech Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year ReadyTech Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by26%, to AU$33m. Shareholders probably have their fingers crossed that it can grow its way to profits.
Despite the top line growth, ReadyTech Holdings still had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost AU$699k at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through AU$1.8m of cash over the last year. So to be blunt we think it is risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how ReadyTech Holdings's profit, revenue, and operating cashflow have changed over the last few years.
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.
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