Is Hargreaves Services (LON:HSP) A Risky Investment?

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, Hargreaves Services Plc (LON:HSP) does carry debt. But should shareholders be worried about its use of debt?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hargreaves Services

What Is Hargreaves Services's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hargreaves Services had UK£11.0m of debt in November 2020, down from UK£49.5m, one year before. However, it does have UK£4.82m in cash offsetting this, leading to net debt of about UK£6.21m.

How Healthy Is Hargreaves Services' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hargreaves Services had liabilities of UK£77.3m due within 12 months and liabilities of UK£12.8m due beyond that. Offsetting this, it had UK£4.82m in cash and UK£87.4m in receivables that were due within 12 months. So it can boast UK£2.14m more liquid assets than total liabilities.

This surplus suggests that Hargreaves Services has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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 Hargreaves Services'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.

Over 12 months, Hargreaves Services made a loss at the EBIT level, and saw its revenue drop to UK£190m, which is a fall of 27%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Hargreaves Services's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost UK£980k at the EBIT level. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. And the cherry on top is that its actual free cash flow was UK£14m with statutory profit coming in at UK£1.0m. So it seems too risky for our taste. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Hargreaves Services has 2 warning signs we think you should be aware of.

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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