Beacon Lighting Group (ASX:BLX) Seems To Use Debt Rather Sparingly

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 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. Importantly, Beacon Lighting Group Limited (ASX:BLX) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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

Check out our latest analysis for Beacon Lighting Group

How Much Debt Does Beacon Lighting Group Carry?

The image below, which you can click on for greater detail, shows that Beacon Lighting Group had debt of AU$21.8m at the end of December 2020, a reduction from AU$41.1m over a year. However, its balance sheet shows it holds AU$50.7m in cash, so it actually has AU$28.9m net cash.

How Strong Is Beacon Lighting Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Beacon Lighting Group had liabilities of AU$88.2m due within 12 months and liabilities of AU$101.2m due beyond that. On the other hand, it had cash of AU$50.7m and AU$11.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$127.2m.

While this might seem like a lot, it is not so bad since Beacon Lighting Group has a market capitalization of AU$404.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Beacon Lighting Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Beacon Lighting Group grew its EBIT by 147% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Beacon Lighting Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Beacon Lighting Group 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, Beacon Lighting Group produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While Beacon Lighting Group does have more liabilities than liquid assets, it also has net cash of AU$28.9m. And we liked the look of last year's 147% year-on-year EBIT growth. So we don't think Beacon Lighting Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Beacon Lighting Group (including 1 which shouldn't be ignored) .

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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