Is Trace Group Hold (BUL:T57) Using Too Much Debt?

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.' 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. Importantly, Trace Group Hold PLC (BUL:T57) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Trace Group Hold

What Is Trace Group Hold's Debt?

The chart below, which you can click on for greater detail, shows that Trace Group Hold had лв12.8m in debt in December 2023; about the same as the year before. However, it does have лв53.9m in cash offsetting this, leading to net cash of лв41.1m.

A Look At Trace Group Hold's Liabilities

According to the last reported balance sheet, Trace Group Hold had liabilities of лв234.6m due within 12 months, and liabilities of лв28.2m due beyond 12 months. Offsetting these obligations, it had cash of лв53.9m as well as receivables valued at лв184.7m due within 12 months. So it has liabilities totalling лв24.3m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Trace Group Hold is worth лв108.9m, 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, Trace Group Hold boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Trace Group Hold grew its EBIT by 601% 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 it is Trace Group Hold's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Trace Group Hold 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. In the last three years, Trace Group Hold created free cash flow amounting to 13% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While Trace Group Hold does have more liabilities than liquid assets, it also has net cash of лв41.1m. And we liked the look of last year's 601% year-on-year EBIT growth. So we don't have any problem with Trace Group Hold's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Trace Group Hold (including 2 which are concerning) .

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.

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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.