These 4 Measures Indicate That Photo-Me International (LON:PHTM) Is Using Debt Reasonably Well

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.' 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. Importantly, Photo-Me International plc (LON:PHTM) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Photo-Me International

How Much Debt Does Photo-Me International Carry?

The image below, which you can click on for greater detail, shows that at October 2020 Photo-Me International had debt of UK£84.9m, up from UK£60.2m in one year. But on the other hand it also has UK£106.2m in cash, leading to a UK£21.3m net cash position.

How Healthy Is Photo-Me International's Balance Sheet?

We can see from the most recent balance sheet that Photo-Me International had liabilities of UK£100.4m falling due within a year, and liabilities of UK£53.0m due beyond that. Offsetting this, it had UK£106.2m in cash and UK£16.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£31.2m.

Given Photo-Me International has a market capitalization of UK£229.8m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Photo-Me International boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Photo-Me International's EBIT was down 95% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Photo-Me International can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Photo-Me International 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, Photo-Me International produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While Photo-Me International does have more liabilities than liquid assets, it also has net cash of UK£21.3m. And it impressed us with free cash flow of UK£26m, being 76% of its EBIT. So we are not troubled with Photo-Me International's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Photo-Me International has 3 warning signs (and 2 which are a bit unpleasant) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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