Is James Cropper (LON:CRPR) 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 can see that James Cropper PLC (LON:CRPR) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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.

View our latest analysis for James Cropper

What Is James Cropper's Net Debt?

The chart below, which you can click on for greater detail, shows that James Cropper had UK£10.8m in debt in September 2020; about the same as the year before. But it also has UK£11.1m in cash to offset that, meaning it has UK£250.0k net cash.

A Look At James Cropper's Liabilities

Zooming in on the latest balance sheet data, we can see that James Cropper had liabilities of UK£25.2m due within 12 months and liabilities of UK£31.8m due beyond that. On the other hand, it had cash of UK£11.1m and UK£20.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£26.0m.

This deficit isn't so bad because James Cropper is worth UK£105.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, James Cropper boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that James Cropper grew its EBIT at 18% over the last year, further increasing its ability to manage debt. 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 James Cropper'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While James Cropper has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, James Cropper recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While James Cropper does have more liabilities than liquid assets, it also has net cash of UK£250.0k. And it impressed us with free cash flow of UK£10m, being 71% of its EBIT. So is James Cropper's debt a risk? It doesn't seem so to us. 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. For example - James Cropper has 1 warning sign we think 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. 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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