Is Comptoir Group (LON:COM) Using Too Much 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 Comptoir Group PLC (LON:COM) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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What Is Comptoir Group's Net Debt?

As you can see below, Comptoir Group had UK£2.50m of debt at July 2022, down from UK£3.00m a year prior. However, its balance sheet shows it holds UK£10.7m in cash, so it actually has UK£8.24m net cash.

How Strong Is Comptoir Group's Balance Sheet?

We can see from the most recent balance sheet that Comptoir Group had liabilities of UK£10.0m falling due within a year, and liabilities of UK£19.7m due beyond that. On the other hand, it had cash of UK£10.7m and UK£1.63m worth of receivables due within a year. So it has liabilities totalling UK£17.3m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the UK£7.05m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Comptoir Group would likely require a major re-capitalisation if it had to pay its creditors today. Given that Comptoir Group has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

We also note that Comptoir Group improved its EBIT from a last year's loss to a positive UK£1.7m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Comptoir Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Comptoir Group 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. Happily for any shareholders, Comptoir Group actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Comptoir Group does have more liabilities than liquid assets, it also has net cash of UK£8.24m. The cherry on top was that in converted 274% of that EBIT to free cash flow, bringing in UK£4.6m. So although we see some areas for improvement, we're not too worried about Comptoir Group's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. 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 2 warning signs for Comptoir Group (of which 1 can't be ignored!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.