Here's Why CSG (ASX:CSV) Has A Meaningful Debt Burden
Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies CSG Limited (ASX:CSV) makes use of 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for CSG
What Is CSG's Net Debt?
The image below, which you can click on for greater detail, shows that CSG had debt of AU$44.7m at the end of June 2019, a reduction from AU$262.6m over a year. However, because it has a cash reserve of AU$26.6m, its net debt is less, at about AU$18.1m.
How Healthy Is CSG's Balance Sheet?
According to the last reported balance sheet, CSG had liabilities of AU$92.2m due within 12 months, and liabilities of AU$196.3m due beyond 12 months. Offsetting these obligations, it had cash of AU$26.6m as well as receivables valued at AU$129.4m due within 12 months. So its liabilities total AU$132.5m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the AU$87.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, CSG would likely require a major re-capitalisation if it had to pay its creditors today.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Given net debt is only 0.77 times EBITDA, it is initially surprising to see that CSG's EBIT has low interest coverage of 1.1 times. So one way or the other, it's clear the debt levels are not trivial. It is well worth noting that CSG's EBIT shot up like bamboo after rain, gaining 77% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if CSG can strengthen its balance sheet over time. 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. So we always check how much of that EBIT is translated into free cash flow. In the last three years, CSG's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Our View
To be frank both CSG's level of total liabilities and its track record of covering its interest expense with its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making CSG stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Given our hesitation about the stock, it would be good to know if CSG insiders have sold any shares recently. You click here to find out if insiders have sold recently.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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 editorial-team@simplywallst.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.
