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 Enprise Group Limited (NZSE:ENS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Enprise Group Carry?
The image below, which you can click on for greater detail, shows that Enprise Group had debt of NZ$635.0k at the end of March 2019, a reduction from NZ$949.0k over a year. However, its balance sheet shows it holds NZ$771.0k in cash, so it actually has NZ$136.0k net cash.
A Look At Enprise Group's Liabilities
We can see from the most recent balance sheet that Enprise Group had liabilities of NZ$2.28m falling due within a year, and liabilities of NZ$321.0k due beyond that. On the other hand, it had cash of NZ$771.0k and NZ$1.61m worth of receivables due within a year. So its liabilities total NZ$223.0k more than the combination of its cash and short-term receivables.
Of course, Enprise Group has a market capitalization of NZ$6.23m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Enprise Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the bad news is that Enprise Group has seen its EBIT plunge 10% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Enprise Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Enprise 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, Enprise Group recorded free cash flow worth 78% 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.
We could understand if investors are concerned about Enprise Group's liabilities, but we can be reassured by the fact it has has net cash of NZ$136k. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in NZ$312k. So we are not troubled with Enprise Group's debt use. Even though Enprise Group lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending over the last few years.
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.
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