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.' 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 can see that Billington Holdings Plc (LON:BILN) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Billington Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that Billington Holdings had debt of UK£1.75m at the end of December 2018, a reduction from UK£2.00m over a year. However, it does have UK£9.31m in cash offsetting this, leading to net cash of UK£7.56m.
How Strong Is Billington Holdings's Balance Sheet?
According to the last reported balance sheet, Billington Holdings had liabilities of UK£19.6m due within 12 months, and liabilities of UK£1.50m due beyond 12 months. Offsetting this, it had UK£9.31m in cash and UK£6.96m in receivables that were due within 12 months. So it has liabilities totalling UK£4.84m more than its cash and near-term receivables, combined.
Since publicly traded Billington Holdings shares are worth a total of UK£36.4m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Billington Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.
And we also note warmly that Billington Holdings grew its EBIT by 11% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Billington Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Billington Holdings 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. During the last three years, Billington Holdings produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Although Billington Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£7.6m. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in UK£2.6m. So is Billington Holdings's debt a risk? It doesn't seem so to us. We'd be very excited to see if Billington Holdings insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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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