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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Sykes Enterprises, Incorporated (NASDAQ:SYKE) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Sykes Enterprises's Net Debt?
The image below, which you can click on for greater detail, shows that Sykes Enterprises had debt of US$49.0m at the end of June 2020, a reduction from US$92.0m over a year. But on the other hand it also has US$129.1m in cash, leading to a US$80.1m net cash position.
A Look At Sykes Enterprises's Liabilities
We can see from the most recent balance sheet that Sykes Enterprises had liabilities of US$260.0m falling due within a year, and liabilities of US$247.0m due beyond that. Offsetting this, it had US$129.1m in cash and US$383.5m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.
This state of affairs indicates that Sykes Enterprises's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$1.27b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Sykes Enterprises has more cash than debt is arguably a good indication that it can manage its debt safely.
Another good sign is that Sykes Enterprises has been able to increase its EBIT by 24% in twelve months, making it easier to pay down 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 Sykes Enterprises'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 Sykes Enterprises 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, Sykes Enterprises produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While we empathize with investors who find debt concerning, you should keep in mind that Sykes Enterprises has net cash of US$80.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in US$86m. So we don't think Sykes Enterprises's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Sykes Enterprises is showing 1 warning sign in our investment analysis , you should know about...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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