We Think Yellow Pages (TSE:Y) Can Stay On Top Of Its Debt

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.' 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. As with many other companies Yellow Pages Limited (TSE:Y) makes use of debt. But the more important question is: how much risk is that debt creating?

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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Yellow Pages

What Is Yellow Pages's Debt?

As you can see below, Yellow Pages had CA$101.8m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CA$170.9m in cash, so it actually has CA$69.2m net cash.

How Healthy Is Yellow Pages' Balance Sheet?

The latest balance sheet data shows that Yellow Pages had liabilities of CA$53.3m due within a year, and liabilities of CA$250.7m falling due after that. On the other hand, it had cash of CA$170.9m and CA$54.8m worth of receivables due within a year. So it has liabilities totalling CA$78.2m more than its cash and near-term receivables, combined.

Yellow Pages has a market capitalization of CA$375.4m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Yellow Pages boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Yellow Pages has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Yellow Pages's ability to maintain a healthy balance sheet going forward. 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. Yellow Pages 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. Over the last three years, Yellow Pages actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While Yellow Pages does have more liabilities than liquid assets, it also has net cash of CA$69.2m. The cherry on top was that in converted 114% of that EBIT to free cash flow, bringing in CA$117m. So we are not troubled with Yellow Pages's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Yellow Pages that 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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