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. We note that Savills plc (LON:SVS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Savills Carry?
You can click the graphic below for the historical numbers, but it shows that Savills had UK£160.6m of debt in December 2020, down from UK£181.4m, one year before. However, it does have UK£338.3m in cash offsetting this, leading to net cash of UK£177.7m.
How Strong Is Savills' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Savills had liabilities of UK£711.1m due within 12 months and liabilities of UK£454.6m due beyond that. On the other hand, it had cash of UK£338.3m and UK£467.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£360.2m.
While this might seem like a lot, it is not so bad since Savills has a market capitalization of UK£1.65b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Savills boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Savills's load is not too heavy, because its EBIT was down 32% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Savills'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Savills may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Savills actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While Savills does have more liabilities than liquid assets, it also has net cash of UK£177.7m. And it impressed us with free cash flow of UK£231m, being 102% of its EBIT. So we are not troubled with Savills's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Savills that 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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