We Think Character Group (LON:CCT) Can Stay On Top Of Its Debt

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 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 note that The Character Group plc (LON:CCT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. 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.

View our latest analysis for Character Group

How Much Debt Does Character Group Carry?

The image below, which you can click on for greater detail, shows that Character Group had debt of UK£3.17m at the end of August 2020, a reduction from UK£23.5m over a year. But it also has UK£22.3m in cash to offset that, meaning it has UK£19.1m net cash.

A Look At Character Group's Liabilities

According to the last reported balance sheet, Character Group had liabilities of UK£33.2m due within 12 months, and liabilities of UK£1.57m due beyond 12 months. Offsetting these obligations, it had cash of UK£22.3m as well as receivables valued at UK£21.8m due within 12 months. So it can boast UK£9.30m more liquid assets than total liabilities.

This short term liquidity is a sign that Character Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Character Group has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Character Group if management cannot prevent a repeat of the 54% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Character Group'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Character Group 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 last three years, Character Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Character Group has net cash of UK£19.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in UK£15m. So we are not troubled with Character Group's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Character Group is showing 4 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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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