The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Telit Communications PLC (LON:TCM) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Telit Communications's Debt?
The image below, which you can click on for greater detail, shows that Telit Communications had debt of US$69.3m at the end of December 2018, a reduction from US$72.5m over a year. On the flip side, it has US$35.0m in cash leading to net debt of about US$34.3m.
How Strong Is Telit Communications's Balance Sheet?
We can see from the most recent balance sheet that Telit Communications had liabilities of US$202.8m falling due within a year, and liabilities of US$29.7m due beyond that. Offsetting this, it had US$35.0m in cash and US$105.5m in receivables that were due within 12 months. So it has liabilities totalling US$92.0m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Telit Communications is worth US$271.6m, 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Telit Communications'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, Telit Communications reported revenue of US$427m, which is a gain of 14%. We usually like to see faster growth from unprofitable companies, but each to their own.
Over the last twelve months Telit Communications produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at US$6.8m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$8.7m of cash over the last year. So suffice it to say we do 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 Telit Communications 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.
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