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 LogiCamms Limited (ASX:LCM) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is LogiCamms's Net Debt?
As you can see below, at the end of June 2019, LogiCamms had AU$3.06m of debt, up from AU$332.0k a year ago. Click the image for more detail. But it also has AU$8.35m in cash to offset that, meaning it has AU$5.29m net cash.
A Look At LogiCamms's Liabilities
We can see from the most recent balance sheet that LogiCamms had liabilities of AU$29.0m falling due within a year, and liabilities of AU$4.85m due beyond that. Offsetting these obligations, it had cash of AU$8.35m as well as receivables valued at AU$29.3m due within 12 months. So it actually has AU$3.86m more liquid assets than total liabilities.
This surplus suggests that LogiCamms has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, LogiCamms boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact LogiCamms's saving grace is its low debt levels, because its EBIT has tanked 82% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is LogiCamms's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While LogiCamms has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, LogiCamms actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While we empathize with investors who find debt concerning, you should keep in mind that LogiCamms has net cash of AU$5.29m, as well as more liquid assets than liabilities. The cherry on top was that in converted 101% of that EBIT to free cash flow, bringing in AU$5.3m. So we are not troubled with LogiCamms's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in LogiCamms, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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.
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. Thank you for reading.