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. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Hamilton Thorne Ltd. (CVE:HTL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Hamilton Thorne
How Much Debt Does Hamilton Thorne Carry?
As you can see below, Hamilton Thorne had US$8.72m of debt at June 2019, down from US$10.3m a year prior. However, it does have US$14.0m in cash offsetting this, leading to net cash of US$5.31m.
How Strong Is Hamilton Thorne's Balance Sheet?
We can see from the most recent balance sheet that Hamilton Thorne had liabilities of US$9.30m falling due within a year, and liabilities of US$6.80m due beyond that. Offsetting this, it had US$14.0m in cash and US$3.32m in receivables that were due within 12 months. So it actually has US$1.25m more liquid assets than total liabilities.
This state of affairs indicates that Hamilton Thorne's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$100.0m company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Hamilton Thorne has more cash than debt is arguably a good indication that it can manage its debt safely.
Notably Hamilton Thorne's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hamilton Thorne'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 company can only pay off debt with cold hard cash, not accounting profits. While Hamilton Thorne 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, Hamilton Thorne produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Hamilton Thorne has net cash of US$5.31m, as well as more liquid assets than liabilities. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in US$3.2m. So we don't have any problem with Hamilton Thorne's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Hamilton Thorne insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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