Here's Why Trainline (LON:TRN) Can Afford Some Debt

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.' 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 Trainline Plc (LON:TRN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Trainline

What Is Trainline's Net Debt?

As you can see below, at the end of February 2021, Trainline had UK£248.8m of debt, up from UK£141.8m a year ago. Click the image for more detail. However, it also had UK£36.6m in cash, and so its net debt is UK£212.3m.

A Look At Trainline's Liabilities

According to the last reported balance sheet, Trainline had liabilities of UK£42.2m due within 12 months, and liabilities of UK£267.2m due beyond 12 months. On the other hand, it had cash of UK£36.6m and UK£17.2m worth of receivables due within a year. So its liabilities total UK£255.6m more than the combination of its cash and short-term receivables.

Given Trainline has a market capitalization of UK£1.63b, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Trainline's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Trainline made a loss at the EBIT level, and saw its revenue drop to UK£67m, which is a fall of 74%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Trainline's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost UK£100m at the EBIT level. 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. However, it doesn't help that it burned through UK£147m of cash over the last year. So suffice it to say we consider the stock very risky. 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. Case in point: We've spotted 2 warning signs for Trainline you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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