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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Crest Nicholson Holdings plc (LON:CRST) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Crest Nicholson Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Crest Nicholson Holdings had UK£97.6m of debt in April 2021, down from UK£348.8m, one year before. However, it does have UK£229.7m in cash offsetting this, leading to net cash of UK£132.1m.
How Healthy Is Crest Nicholson Holdings' Balance Sheet?
We can see from the most recent balance sheet that Crest Nicholson Holdings had liabilities of UK£364.8m falling due within a year, and liabilities of UK£236.9m due beyond that. On the other hand, it had cash of UK£229.7m and UK£83.6m worth of receivables due within a year. So its liabilities total UK£288.4m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Crest Nicholson Holdings is worth UK£957.1m, 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. While it does have liabilities worth noting, Crest Nicholson Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.
And we also note warmly that Crest Nicholson Holdings grew its EBIT by 11% last year, making its debt load easier 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 Crest Nicholson Holdings 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. Crest Nicholson Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Crest Nicholson Holdings 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.
Although Crest Nicholson Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£132.1m. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in UK£229m. So is Crest Nicholson Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Crest Nicholson Holdings .
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
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