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. 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 note that CSP International Fashion Group S.p.A. (BIT:CSP) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does CSP International Fashion Group Carry?
The image below, which you can click on for greater detail, shows that CSP International Fashion Group had debt of €15.5m at the end of June 2019, a reduction from €21.6m over a year. But it also has €19.3m in cash to offset that, meaning it has €3.73m net cash.
A Look At CSP International Fashion Group’s Liabilities
Zooming in on the latest balance sheet data, we can see that CSP International Fashion Group had liabilities of €37.7m due within 12 months and liabilities of €22.9m due beyond that. Offsetting this, it had €19.3m in cash and €17.6m in receivables that were due within 12 months. So its liabilities total €23.7m more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company’s €18.8m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. CSP International Fashion Group boasts net cash, so it’s fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. When analysing debt levels, the balance sheet is the obvious place to start. But it is CSP International Fashion Group’s earnings that will influence how the balance sheet holds up in the future. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year CSP International Fashion Group had negative earnings before interest and tax, and actually shrunk its revenue by 8.2%, to €110m. We would much prefer see growth.
So How Risky Is CSP International Fashion Group?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year CSP International Fashion Group had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through €1.0m of cash and made a loss of €13m. While this does make the company a bit risky, it’s important to remember it has net cash of €3.73m. That means it could keep spending at its current rate for more than two years. Overall, we’d say the stock is a bit risky, and we’re usually very cautious until we see positive free cash flow. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. For instance, we’ve identified 3 warning signs for CSP International Fashion Group (1 is a bit unpleasant) you should be aware of.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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.
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