Here's Why Trifast (LON:TRI) Can Manage Its Debt Responsibly

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. We can see that Trifast plc (LON:TRI) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Trifast

How Much Debt Does Trifast Carry?

The image below, which you can click on for greater detail, shows that Trifast had debt of UK£26.5m at the end of September 2020, a reduction from UK£40.7m over a year. But it also has UK£29.8m in cash to offset that, meaning it has UK£3.27m net cash.

A Look At Trifast's Liabilities

The latest balance sheet data shows that Trifast had liabilities of UK£38.9m due within a year, and liabilities of UK£42.2m falling due after that. Offsetting these obligations, it had cash of UK£29.8m as well as receivables valued at UK£49.3m due within 12 months. So its liabilities total UK£2.04m more than the combination of its cash and short-term receivables.

Having regard to Trifast's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the UK£180.2m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Trifast 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 Trifast if management cannot prevent a repeat of the 58% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Trifast's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Trifast 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. During the last three years, Trifast produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

We could understand if investors are concerned about Trifast's liabilities, but we can be reassured by the fact it has has net cash of UK£3.27m. So we are not troubled with Trifast's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Trifast you should be aware of.

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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