Here's Why Tyman (LON:TYMN) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Tyman plc (LON:TYMN) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

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What Is Tyman's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Tyman had debt of UK£211.8m, up from UK£156.1m in one year. However, because it has a cash reserve of UK£86.7m, its net debt is less, at about UK£125.1m.

How Healthy Is Tyman's Balance Sheet?

The latest balance sheet data shows that Tyman had liabilities of UK£168.2m due within a year, and liabilities of UK£267.7m falling due after that. Offsetting these obligations, it had cash of UK£86.7m as well as receivables valued at UK£107.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£241.5m.

This deficit isn't so bad because Tyman is worth UK£410.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt sitting at just 1.2 times EBITDA, Tyman is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 8.8 times the interest expense over the last year. But the other side of the story is that Tyman saw its EBIT decline by 6.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Tyman 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Tyman generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

On our analysis Tyman's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its EBIT growth rate makes us a little nervous about its debt. Considering this range of data points, we think Tyman is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Tyman , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.