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. We note that Calian Group Ltd. (TSE:CGY) does have debt on its balance sheet. 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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Calian Group Carry?
As you can see below, at the end of March 2021, Calian Group had CA$55.0m of debt, up from none a year ago. Click the image for more detail. However, it does have CA$119.9m in cash offsetting this, leading to net cash of CA$64.9m.
A Look At Calian Group's Liabilities
Zooming in on the latest balance sheet data, we can see that Calian Group had liabilities of CA$172.8m due within 12 months and liabilities of CA$55.6m due beyond that. Offsetting these obligations, it had cash of CA$119.9m as well as receivables valued at CA$186.0m due within 12 months. So it actually has CA$77.6m more liquid assets than total liabilities.
This short term liquidity is a sign that Calian Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Calian Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that Calian Group grew its EBIT at 10% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Calian 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Calian 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. In the last three years, Calian Group's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Calian Group has net cash of CA$64.9m, as well as more liquid assets than liabilities. And it also grew its EBIT by 10% over the last year. So we don't think Calian Group's use of debt is risky. 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 be aware of the 2 warning signs we've spotted with Calian Group .
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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