David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Porvair plc (LON:PRV) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
What Is Porvair's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of November 2020 Porvair had UK£10.7m of debt, an increase on UK£8.88m, over one year. However, its balance sheet shows it holds UK£15.6m in cash, so it actually has UK£4.88m net cash.
How Strong Is Porvair's Balance Sheet?
We can see from the most recent balance sheet that Porvair had liabilities of UK£28.1m falling due within a year, and liabilities of UK£39.4m due beyond that. Offsetting this, it had UK£15.6m in cash and UK£20.7m in receivables that were due within 12 months. So its liabilities total UK£31.3m more than the combination of its cash and short-term receivables.
Since publicly traded Porvair shares are worth a total of UK£244.3m, 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. While it does have liabilities worth noting, Porvair also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Porvair's EBIT dived 13%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Porvair'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Porvair 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. Over the most recent three years, Porvair recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While Porvair does have more liabilities than liquid assets, it also has net cash of UK£4.88m. So we are not troubled with Porvair's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Porvair, you may well want to click here to check an interactive graph of its earnings per share history.
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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