Here's Why Quickstep Holdings (ASX:QHL) Has A Meaningful Debt Burden

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, Quickstep Holdings Limited (ASX:QHL) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Quickstep Holdings

How Much Debt Does Quickstep Holdings Carry?

The image below, which you can click on for greater detail, shows that Quickstep Holdings had debt of AU$6.26m at the end of December 2020, a reduction from AU$8.84m over a year. However, because it has a cash reserve of AU$2.60m, its net debt is less, at about AU$3.66m.

A Look At Quickstep Holdings' Liabilities

The latest balance sheet data shows that Quickstep Holdings had liabilities of AU$18.3m due within a year, and liabilities of AU$20.3m falling due after that. Offsetting this, it had AU$2.60m in cash and AU$13.7m in receivables that were due within 12 months. So its liabilities total AU$22.3m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Quickstep Holdings has a market capitalization of AU$37.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Quickstep Holdings has a very low debt to EBITDA ratio of 0.61 so it is strange to see weak interest coverage, with last year's EBIT being only 2.3 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Unfortunately, Quickstep Holdings saw its EBIT slide 9.5% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Quickstep Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Quickstep Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We'd go so far as to say Quickstep Holdings's conversion of EBIT to free cash flow was disappointing. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Quickstep Holdings has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. Be aware that Quickstep Holdings is showing 2 warning signs in our investment analysis , you should know about...

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.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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