These 4 Measures Indicate That Clover (ASX:CLV) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Clover Corporation Limited (ASX:CLV) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, 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.

View our latest analysis for Clover

What Is Clover's Debt?

You can click the graphic below for the historical numbers, but it shows that Clover had AU$9.43m of debt in July 2023, down from AU$10.9m, one year before. However, it does have AU$9.44m in cash offsetting this, leading to net cash of AU$4.0k.

How Healthy Is Clover's Balance Sheet?

The latest balance sheet data shows that Clover had liabilities of AU$8.29m due within a year, and liabilities of AU$10.8m falling due after that. Offsetting these obligations, it had cash of AU$9.44m as well as receivables valued at AU$11.9m due within 12 months. So it can boast AU$2.33m more liquid assets than total liabilities.

This state of affairs indicates that Clover's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the AU$141.1m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Clover has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Clover's EBIT dived 16%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Clover's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Clover 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. During the last three years, Clover produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Clover has net cash of AU$4.0k, as well as more liquid assets than liabilities. So we don't have any problem with Clover's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Clover, you may well want to click here to check an interactive graph of its earnings per share history.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.