Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, CL Educate Limited (NSE:CLEDUCATE) does carry debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 think about a company's use of debt, we first look at cash and debt together.
What Is CL Educate's Net Debt?
The chart below, which you can click on for greater detail, shows that CL Educate had ₹519.6m in debt in March 2019; about the same as the year before. But on the other hand it also has ₹600.3m in cash, leading to a ₹80.6m net cash position.
A Look At CL Educate's Liabilities
According to the last reported balance sheet, CL Educate had liabilities of ₹1.38b due within 12 months, and liabilities of ₹173.2m due beyond 12 months. Offsetting this, it had ₹600.3m in cash and ₹1.64b in receivables that were due within 12 months. So it can boast ₹689.5m more liquid assets than total liabilities.
This surplus liquidity suggests that CL Educate's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that CL Educate has more cash than debt is arguably a good indication that it can manage its debt safely.
Notably, CL Educate's EBIT launched higher than Elon Musk, gaining a whopping 188% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since CL Educate will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. CL Educate 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, CL Educate burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While it is always sensible to investigate a company's debt, in this case CL Educate has ₹80.6m in net cash and a decent-looking balance sheet. And we liked the look of last year's 188% year-on-year EBIT growth. So is CL Educate's debt a risk? It doesn't seem so to us. We'd be motivated to research the stock further if we found out that CL Educate insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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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