Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that LendLease Group (ASX:LLC) does use debt in its business. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is LendLease Group's Debt?
The image below, which you can click on for greater detail, shows that at December 2018 LendLease Group had debt of AU$3.36b, up from AU$1.79b in one year. On the flip side, it has AU$1.09b in cash leading to net debt of about AU$2.28b.
A Look At LendLease Group's Liabilities
Zooming in on the latest balance sheet data, we can see that LendLease Group had liabilities of AU$6.16b due within 12 months and liabilities of AU$5.20b due beyond that. Offsetting these obligations, it had cash of AU$1.09b as well as receivables valued at AU$2.20b due within 12 months. So it has liabilities totalling AU$8.07b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's AU$7.59b market capitalization, you might well be inclined to review the balance sheet, just like one might study a new partner's social media. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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 LendLease 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.
Over 12 months, LendLease Group saw its revenue drop to AU$16b, which is a fall of 10%. That's not what we would hope to see.
While LendLease Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost AU$219m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through AU$1.3b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting LendLease Group insider transactions.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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 firstname.lastname@example.org. 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.