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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Beacon Lighting Group Limited (ASX:BLX) makes use of debt. But the real question is whether this debt is making the company risky.
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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Beacon Lighting Group's Net Debt?
As you can see below, Beacon Lighting Group had AU$19.0m of debt at June 2021, down from AU$31.0m a year prior. But on the other hand it also has AU$33.8m in cash, leading to a AU$14.9m net cash position.
How Healthy 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$79.2m due within 12 months and liabilities of AU$98.6m due beyond that. Offsetting this, it had AU$33.8m in cash and AU$7.79m in receivables that were due within 12 months. So its liabilities total AU$136.2m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Beacon Lighting Group is worth AU$451.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Beacon Lighting Group boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Beacon Lighting Group grew its EBIT by 97% over the last twelve months, and that growth will make it easier to handle its debt. 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 Beacon Lighting Group 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. While Beacon Lighting Group 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. During the last three years, Beacon Lighting Group generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While Beacon Lighting Group does have more liabilities than liquid assets, it also has net cash of AU$14.9m. And it impressed us with free cash flow of AU$53m, being 83% of its EBIT. So is Beacon Lighting Group's debt a risk? It doesn't seem so to us. 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. Be aware that Beacon Lighting Group is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
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