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.' 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, Lendlease Group (ASX:LLC) does carry debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
What Is Lendlease Group's Debt?
The image below, which you can click on for greater detail, shows that Lendlease Group had debt of AU$2.72b at the end of December 2020, a reduction from AU$3.39b over a year. However, it does have AU$899.0m in cash offsetting this, leading to net debt of about AU$1.82b.
How Healthy Is Lendlease Group's Balance Sheet?
We can see from the most recent balance sheet that Lendlease Group had liabilities of AU$5.26b falling due within a year, and liabilities of AU$4.22b due beyond that. On the other hand, it had cash of AU$899.0m and AU$1.66b worth of receivables due within a year. So it has liabilities totalling AU$6.92b more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of AU$8.84b, so it does suggest shareholders should keep an eye on Lendlease Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 Lendlease Group'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.
In the last year Lendlease Group had a loss before interest and tax, and actually shrunk its revenue by 34%, to AU$10b. That makes us nervous, to say the least.
While Lendlease Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost AU$639m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through AU$204m of cash over the last year. So to be blunt we think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Lendlease Group , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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