Craneware (LON:CRW) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Craneware plc (LON:CRW) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that CRW is potentially undervalued!

How Much Debt Does Craneware Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Craneware had US$111.6m of debt, an increase on none, over one year. However, because it has a cash reserve of US$47.2m, its net debt is less, at about US$64.4m.

How Strong Is Craneware's Balance Sheet?

According to the last reported balance sheet, Craneware had liabilities of US$82.5m due within 12 months, and liabilities of US$153.3m due beyond 12 months. On the other hand, it had cash of US$47.2m and US$35.3m worth of receivables due within a year. So it has liabilities totalling US$153.3m more than its cash and near-term receivables, combined.

Since publicly traded Craneware shares are worth a total of US$872.7m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Craneware's net debt is sitting at a very reasonable 1.5 times its EBITDA, while its EBIT covered its interest expense just 4.0 times last year. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. We saw Craneware grow its EBIT by 2.6% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Craneware 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Craneware produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

We feel that Craneware's solid conversion of EBIT to free cash flow was really heart warming, like a mid-winter fair trade hot chocolate in a tasteful alpine chalet. But we are a little concerned by its interest cover. It's also worth noting that Craneware is in the Healthcare Services industry, which is often considered to be quite defensive. Looking at all the aforementioned factors together, it strikes us that Craneware can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Craneware you should know about.

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.