Is CountPlus (ASX:CUP) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that CountPlus Limited (ASX:CUP) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for CountPlus

How Much Debt Does CountPlus Carry?

You can click the graphic below for the historical numbers, but it shows that CountPlus had AU$4.85m of debt in December 2020, down from AU$5.39m, one year before. But it also has AU$27.6m in cash to offset that, meaning it has AU$22.8m net cash.

How Strong Is CountPlus' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CountPlus had liabilities of AU$259.8m due within 12 months and liabilities of AU$38.1m due beyond that. Offsetting these obligations, it had cash of AU$27.6m as well as receivables valued at AU$253.6m due within 12 months. So its liabilities total AU$16.6m more than the combination of its cash and short-term receivables.

Of course, CountPlus has a market capitalization of AU$137.3m, so these liabilities are probably manageable. 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, CountPlus also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that CountPlus grew its EBIT by 783% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CountPlus 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. CountPlus 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, CountPlus 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.

Summing up

Although CountPlus's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$22.8m. The cherry on top was that in converted 118% of that EBIT to free cash flow, bringing in AU$15m. So we don't think CountPlus's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for CountPlus that you should be aware of before investing here.

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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