These 4 Measures Indicate That PayPoint (LON:PAY) Is Using Debt Safely

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies PayPoint plc (LON:PAY) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for PayPoint

What Is PayPoint's Debt?

As you can see below, at the end of September 2020, PayPoint had UK£21.0m of debt, up from UK£18.0m a year ago. Click the image for more detail. However, it does have UK£42.0m in cash offsetting this, leading to net cash of UK£21.0m.

How Strong Is PayPoint's Balance Sheet?

The latest balance sheet data shows that PayPoint had liabilities of UK£163.4m due within a year, and liabilities of UK£12.0k falling due after that. Offsetting this, it had UK£42.0m in cash and UK£67.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£53.5m.

Since publicly traded PayPoint shares are worth a total of UK£401.9m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, PayPoint also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, PayPoint grew its EBIT by 8.6% in the last year, making that debt load look even more manageable. 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 PayPoint'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While PayPoint 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, PayPoint generated free cash flow amounting to a very robust 97% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While PayPoint does have more liabilities than liquid assets, it also has net cash of UK£21.0m. And it impressed us with free cash flow of UK£53m, being 97% of its EBIT. So we don't think PayPoint's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for PayPoint (of which 1 is concerning!) you should know about.

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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