TClarke (LON:CTO) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, TClarke plc (LON:CTO) does carry 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for TClarke

How Much Debt Does TClarke Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 TClarke had UK£15.0m of debt, an increase on none, over one year. However, it does have UK£25.2m in cash offsetting this, leading to net cash of UK£10.2m.

How Strong Is TClarke's Balance Sheet?

The latest balance sheet data shows that TClarke had liabilities of UK£94.9m due within a year, and liabilities of UK£35.0m falling due after that. Offsetting this, it had UK£25.2m in cash and UK£76.9m in receivables that were due within 12 months. So it has liabilities totalling UK£27.8m more than its cash and near-term receivables, combined.

TClarke has a market capitalization of UK£48.1m, 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. While it does have liabilities worth noting, TClarke also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for TClarke if management cannot prevent a repeat of the 43% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if TClarke 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. While TClarke 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. Looking at the most recent three years, TClarke recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

Although TClarke'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£10.2m. So although we see some areas for improvement, we're not too worried about TClarke's balance sheet. 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 5 warning signs for TClarke that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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