Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Leeds Group plc (LON:LDSG) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Leeds Group's Net Debt?
As you can see below, Leeds Group had UK£4.62m of debt, at May 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has UK£670.0k in cash leading to net debt of about UK£3.95m.
A Look At Leeds Group's Liabilities
We can see from the most recent balance sheet that Leeds Group had liabilities of UK£6.31m falling due within a year, and liabilities of UK£3.35m due beyond that. Offsetting this, it had UK£670.0k in cash and UK£2.87m in receivables that were due within 12 months. So it has liabilities totalling UK£6.12m more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's UK£5.74m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Leeds Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Over 12 months, Leeds Group made a loss at the EBIT level, and saw its revenue drop to UK£33m, which is a fall of 5.9%. That's not what we would hope to see.
Over the last twelve months Leeds Group produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping UK£985k. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through UK£139k in negative free cash flow over the last year. That means it's on the risky side of things. 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. Case in point: We've spotted 3 warning signs for Leeds Group you should be aware of, and 2 of them are a bit concerning.
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.
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.
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