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, Eckoh plc (LON:ECK) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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 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, 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Eckoh’s Debt?
As you can see below, Eckoh had UK£3.25m of debt at March 2019, down from UK£4.55m a year prior. But it also has UK£11.6m in cash to offset that, meaning it has UK£8.33m net cash.
How Healthy Is Eckoh’s Balance Sheet?
The latest balance sheet data shows that Eckoh had liabilities of UK£21.3m due within a year, and liabilities of UK£2.45m falling due after that. On the other hand, it had cash of UK£11.6m and UK£4.87m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£7.28m.
Since publicly traded Eckoh shares are worth a total of UK£116.2m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Eckoh boasts net cash, so it’s fair to say it does not have a heavy debt load!
In addition to that, we’re happy to report that Eckoh has boosted its EBIT by 52%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Eckoh 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 company can only pay off debt with cold hard cash, not accounting profits. Eckoh 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. Over the last three years, Eckoh actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that Eckoh has UK£8.3m in net cash. And it impressed us with free cash flow of UK£6.3m, being 308% of its EBIT. So we don’t think Eckoh’s use of debt is risky. We’d be very excited to see if Eckoh 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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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Thank you for reading.