Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Flight Centre Travel Group Limited (ASX:FLT) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Flight Centre Travel Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Flight Centre Travel Group had AU$185.1m of debt, an increase on AU$35.5, over one year. But it also has AU$352.3m in cash to offset that, meaning it has AU$167.2m net cash.
How Strong Is Flight Centre Travel Group's Balance Sheet?
We can see from the most recent balance sheet that Flight Centre Travel Group had liabilities of AU$1.76b falling due within a year, and liabilities of AU$276.0m due beyond that. Offsetting this, it had AU$352.3m in cash and AU$932.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$746.5m.
Given Flight Centre Travel Group has a market capitalization of AU$4.50b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Flight Centre Travel Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Flight Centre Travel Group saw its EBIT drop by 3.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Flight Centre Travel Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Flight Centre Travel 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. Over the most recent three years, Flight Centre Travel Group recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Although Flight Centre Travel Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$167.2m. So we are not troubled with Flight Centre Travel Group's debt use. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Flight Centre Travel Group's dividend history, without delay!
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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.
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