The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that HT&E Limited (ASX:HT1) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does HT&E Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 HT&E had AU$2.93m of debt, an increase on none, over one year. But it also has AU$115.1m in cash to offset that, meaning it has AU$112.1m net cash.
How Healthy Is HT&E's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that HT&E had liabilities of AU$45.2m due within 12 months and liabilities of AU$156.9m due beyond that. Offsetting these obligations, it had cash of AU$115.1m as well as receivables valued at AU$45.5m due within 12 months. So its liabilities total AU$41.6m more than the combination of its cash and short-term receivables.
Since publicly traded HT&E shares are worth a total of AU$451.0m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, HT&E also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, HT&E's EBIT dived 11%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if HT&E can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While HT&E has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, HT&E's free cash flow amounted to 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
We could understand if investors are concerned about HT&E's liabilities, but we can be reassured by the fact it has has net cash of AU$112.1m. So we don't have any problem with HT&E's use of debt. Even though HT&E lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.
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 decide to trade HT&E, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.