Countryside Properties (LON:CSP) Takes On Some Risk With Its Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Countryside Properties PLC (LON:CSP) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Countryside Properties

What Is Countryside Properties's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Countryside Properties had debt of UK£2.30m, up from UK£2.20m in one year. However, its balance sheet shows it holds UK£100.5m in cash, so it actually has UK£98.2m net cash.

How Strong Is Countryside Properties' Balance Sheet?

The latest balance sheet data shows that Countryside Properties had liabilities of UK£361.4m due within a year, and liabilities of UK£162.4m falling due after that. Offsetting this, it had UK£100.5m in cash and UK£162.5m in receivables that were due within 12 months. So its liabilities total UK£260.8m more than the combination of its cash and short-term receivables.

Given Countryside Properties has a market capitalization of UK£2.62b, it's hard to believe these liabilities pose much 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, Countryside Properties also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Countryside Properties's saving grace is its low debt levels, because its EBIT has tanked 78% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Countryside Properties'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Countryside Properties 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. Considering the last three years, Countryside Properties actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Countryside Properties has UK£98.2m in net cash. So while Countryside Properties does not have a great balance sheet, it's certainly not too bad. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Countryside Properties you should know about.

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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