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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Senior plc (LON:SNR) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Senior
What Is Senior's Debt?
The image below, which you can click on for greater detail, shows that Senior had debt of UK£153.0m at the end of December 2020, a reduction from UK£161.7m over a year. However, it also had UK£23.6m in cash, and so its net debt is UK£129.4m.
A Look At Senior's Liabilities
Zooming in on the latest balance sheet data, we can see that Senior had liabilities of UK£170.3m due within 12 months and liabilities of UK£251.1m due beyond that. Offsetting this, it had UK£23.6m in cash and UK£76.6m in receivables that were due within 12 months. So its liabilities total UK£321.2m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of UK£483.6m, so it does suggest shareholders should keep an eye on Senior's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Senior can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Senior made a loss at the EBIT level, and saw its revenue drop to UK£734m, which is a fall of 34%. That makes us nervous, to say the least.
Caveat Emptor
While Senior's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable UK£178m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of UK£159m. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Senior .
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. 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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About LSE:SNR
Senior
Designs, manufactures, and sells high-technology components and systems for the principal original equipment manufacturers in the aerospace, defense, land vehicle, and power and energy markets in the United States, the United Kingdom, and internationally.
Undervalued with solid track record.