Bodycote (LON:BOY) Seems To Use Debt Rather Sparingly

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.' 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 can see that Bodycote plc (LON:BOY) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Bodycote

What Is Bodycote's Net Debt?

The image below, which you can click on for greater detail, shows that Bodycote had debt of UK£32.6m at the end of December 2023, a reduction from UK£70.9m over a year. However, it does have UK£45.2m in cash offsetting this, leading to net cash of UK£12.6m.

A Look At Bodycote's Liabilities

The latest balance sheet data shows that Bodycote had liabilities of UK£225.1m due within a year, and liabilities of UK£119.3m falling due after that. Offsetting these obligations, it had cash of UK£45.2m as well as receivables valued at UK£151.4m due within 12 months. So its liabilities total UK£147.8m more than the combination of its cash and short-term receivables.

Since publicly traded Bodycote shares are worth a total of UK£1.28b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Bodycote boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Bodycote grew its EBIT by 15% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Bodycote 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Bodycote 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. During the last three years, Bodycote generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Bodycote's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£12.6m. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in UK£109m. So we don't think Bodycote's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Bodycote .

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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