Is Plexus Holdings (LON:POS) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Plexus Holdings plc (LON:POS) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Plexus Holdings

What Is Plexus Holdings's Debt?

As you can see below, at the end of December 2023, Plexus Holdings had UK£1.80m of debt, up from UK£1.58m a year ago. Click the image for more detail. However, it does have UK£833.0k in cash offsetting this, leading to net debt of about UK£965.0k.

A Look At Plexus Holdings' Liabilities

The latest balance sheet data shows that Plexus Holdings had liabilities of UK£5.76m due within a year, and liabilities of UK£2.08m falling due after that. On the other hand, it had cash of UK£833.0k and UK£7.13m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

Having regard to Plexus Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the UK£14.8m company is struggling for cash, we still think it's worth monitoring its balance sheet.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Plexus Holdings has a very low debt to EBITDA ratio of 0.73 so it is strange to see weak interest coverage, with last year's EBIT being only 0.044 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that Plexus Holdings improved its EBIT from a last year's loss to a positive UK£4.0k. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Plexus Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Plexus Holdings burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Both Plexus Holdings's conversion of EBIT to free cash flow and its interest cover were discouraging. But on the brighter side of life, its net debt to EBITDA leaves us feeling more frolicsome. Looking at all the angles mentioned above, it does seem to us that Plexus Holdings is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For instance, we've identified 4 warning signs for Plexus Holdings (1 doesn't sit too well with us) you should be aware of.

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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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.