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.’ 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 BMTC Group Inc. (TSE:GBT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does BMTC Group Carry?
The image below, which you can click on for greater detail, shows that at April 2019 BMTC Group had debt of CA$13.5m, up from none in one year. But on the other hand it also has CA$17.9m in cash, leading to a CA$4.37m net cash position.
A Look At BMTC Group’s Liabilities
We can see from the most recent balance sheet that BMTC Group had liabilities of CA$151.0m falling due within a year, and liabilities of CA$21.4m due beyond that. Offsetting this, it had CA$17.9m in cash and CA$14.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$140.5m.
BMTC Group has a market capitalization of CA$367.3m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, BMTC Group also has more cash than debt, so we’re pretty confident it can manage its debt safely.
It is just as well that BMTC Group’s load is not too heavy, because its EBIT was down 22% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can’t view debt in total isolation; since BMTC Group 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. BMTC Group 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 most recent three years, BMTC Group recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Although BMTC Group’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CA$4.4m. So we are not troubled with BMTC Group’s debt use. 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 BMTC Group’s earnings per share history for free.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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