Is TWC Enterprises (TSE:TWC) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that TWC Enterprises Limited (TSE:TWC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for TWC Enterprises

How Much Debt Does TWC Enterprises Carry?

You can click the graphic below for the historical numbers, but it shows that TWC Enterprises had CA$118.2m of debt in December 2020, down from CA$131.1m, one year before. But it also has CA$127.1m in cash to offset that, meaning it has CA$8.86m net cash.

How Healthy Is TWC Enterprises' Balance Sheet?

We can see from the most recent balance sheet that TWC Enterprises had liabilities of CA$64.6m falling due within a year, and liabilities of CA$153.4m due beyond that. Offsetting these obligations, it had cash of CA$127.1m as well as receivables valued at CA$35.6m due within 12 months. So it has liabilities totalling CA$55.4m more than its cash and near-term receivables, combined.

Given TWC Enterprises has a market capitalization of CA$590.4m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, TWC Enterprises boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that TWC Enterprises grew its EBIT by 109% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since TWC Enterprises will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. TWC Enterprises 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. Looking at the most recent three years, TWC Enterprises recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

We could understand if investors are concerned about TWC Enterprises's liabilities, but we can be reassured by the fact it has has net cash of CA$8.86m. And we liked the look of last year's 109% year-on-year EBIT growth. So is TWC Enterprises'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. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for TWC Enterprises that you should be aware of.

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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