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. We note that Billington Holdings Plc (LON:BILN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Billington Holdings's Debt?
As you can see below, Billington Holdings had UK£1.36m of debt at June 2020, down from UK£1.63m a year prior. However, its balance sheet shows it holds UK£17.5m in cash, so it actually has UK£16.1m net cash.
How Strong Is Billington Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Billington Holdings had liabilities of UK£20.6m due within 12 months and liabilities of UK£176.0k due beyond that. Offsetting these obligations, it had cash of UK£17.5m as well as receivables valued at UK£8.67m due within 12 months. So it can boast UK£5.37m more liquid assets than total liabilities.
This excess liquidity suggests that Billington Holdings is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Billington Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact Billington Holdings's saving grace is its low debt levels, because its EBIT has tanked 32% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Billington Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Billington Holdings 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, Billington Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case Billington Holdings has UK£16.1m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in UK£7.7m. So we don't think Billington Holdings's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Billington Holdings has 2 warning signs we think you should be aware of.
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.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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