David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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, Porvair plc (LON:PRV) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Porvair Carry?
You can click the graphic below for the historical numbers, but it shows that as of May 2019 Porvair had UK£4.95m of debt, an increase on UK£6.3, over one year. However, its balance sheet shows it holds UK£8.19m in cash, so it actually has UK£3.25m net cash.
How Healthy Is Porvair's Balance Sheet?
We can see from the most recent balance sheet that Porvair had liabilities of UK£35.6m falling due within a year, and liabilities of UK£22.1m due beyond that. Offsetting these obligations, it had cash of UK£8.19m as well as receivables valued at UK£26.4m due within 12 months. So its liabilities total UK£23.1m more than the combination of its cash and short-term receivables.
Given Porvair has a market capitalization of UK£327.8m, it's hard to believe these liabilities pose much 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, Porvair also has more cash than debt, so we're pretty confident it can manage its debt safely.
And we also note warmly that Porvair grew its EBIT by 19% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Porvair 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Porvair 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. In the last three years, Porvair's free cash flow amounted to 45% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Porvair has UK£3.25m in net cash. And we liked the look of last year's 19% year-on-year EBIT growth. So we don't think Porvair's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Porvair's earnings per share history for free.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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.