Stock Analysis

Is Hornby (LON:HRN) Using Too Much Debt?

AIM:HRN
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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Hornby PLC (LON:HRN) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, 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.

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How Much Debt Does Hornby Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Hornby had debt of UK£19.6m, up from UK£15.8m in one year. However, it also had UK£730.0k in cash, and so its net debt is UK£18.9m.

debt-equity-history-analysis
AIM:HRN Debt to Equity History January 3rd 2025

How Healthy Is Hornby's Balance Sheet?

According to the last reported balance sheet, Hornby had liabilities of UK£34.2m due within 12 months, and liabilities of UK£2.61m due beyond 12 months. Offsetting this, it had UK£730.0k in cash and UK£9.40m in receivables that were due within 12 months. So it has liabilities totalling UK£26.7m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Hornby has a market capitalization of UK£44.5m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But it is Hornby's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Hornby wasn't profitable at an EBIT level, but managed to grow its revenue by 5.7%, to UK£59m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Hornby had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping UK£6.4m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled UK£3.7m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. We've identified 4 warning signs with Hornby (at least 3 which are potentially serious) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.