Stock Analysis

We Think Exco Technologies (TSE:XTC) Can Stay On Top Of Its Debt

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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. We can see that Exco Technologies Limited (TSE:XTC) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Exco Technologies

How Much Debt Does Exco Technologies Carry?

The image below, which you can click on for greater detail, shows that at March 2020 Exco Technologies had debt of CA$23.7m, up from CA$20.4m in one year. However, its balance sheet shows it holds CA$35.7m in cash, so it actually has CA$11.9m net cash.

TSX:XTC Historical Debt July 3rd 2020
TSX:XTC Historical Debt July 3rd 2020

A Look At Exco Technologies's Liabilities

The latest balance sheet data shows that Exco Technologies had liabilities of CA$71.4m due within a year, and liabilities of CA$31.0m falling due after that. On the other hand, it had cash of CA$35.7m and CA$99.7m worth of receivables due within a year. So it actually has CA$32.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Exco Technologies could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Exco Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Exco Technologies if management cannot prevent a repeat of the 25% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Exco Technologies 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 company can only pay off debt with cold hard cash, not accounting profits. While Exco Technologies 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, Exco Technologies produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Exco Technologies has CA$11.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in CA$47m. So we don't have any problem with Exco Technologies's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Exco Technologies you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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