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. As with many other companies CSG Systems International, Inc. (NASDAQ:CSGS) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is CSG Systems International's Net Debt?
As you can see below, CSG Systems International had US$358.3m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have US$131.5m in cash offsetting this, leading to net debt of about US$226.8m.
How Strong Is CSG Systems International's Balance Sheet?
According to the last reported balance sheet, CSG Systems International had liabilities of US$335.6m due within 12 months, and liabilities of US$469.8m due beyond 12 months. Offsetting these obligations, it had cash of US$131.5m as well as receivables valued at US$312.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$361.7m.
This deficit isn't so bad because CSG Systems International is worth US$1.63b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Looking at its net debt to EBITDA of 1.4 and interest cover of 6.9 times, it seems to us that CSG Systems International is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. And we also note warmly that CSG Systems International grew its EBIT by 13% last year, making its debt load easier to handle. 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 Systems International 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, CSG Systems International produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
On this analysis, CSG Systems International's EBIT growth rate was a real positive, just like an unsolicited gift of cupcakes from a work colleague. And its apparent ability to to convert EBIT to free cash flow is also rather rousing! Looking at all the aforementioned factors together, it strikes us that CSG Systems International can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. We'd be motivated to research the stock further if we found out that CSG Systems International insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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