Does ULS Technology (LON:ULS) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 ULS Technology plc (LON:ULS) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for ULS Technology

How Much Debt Does ULS Technology Carry?

The image below, which you can click on for greater detail, shows that ULS Technology had debt of UK£5.75m at the end of September 2020, a reduction from UK£6.25m over a year. However, because it has a cash reserve of UK£3.82m, its net debt is less, at about UK£1.93m.

A Look At ULS Technology's Liabilities

The latest balance sheet data shows that ULS Technology had liabilities of UK£9.55m due within a year, and liabilities of UK£2.99m falling due after that. On the other hand, it had cash of UK£3.82m and UK£1.51m worth of receivables due within a year. So it has liabilities totalling UK£7.21m more than its cash and near-term receivables, combined.

Since publicly traded ULS Technology shares are worth a total of UK£51.8m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

ULS Technology's net debt is only 0.69 times its EBITDA. And its EBIT easily covers its interest expense, being 11.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for ULS Technology if management cannot prevent a repeat of the 59% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if ULS Technology 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, ULS Technology recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

ULS Technology's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its EBIT growth rate. All these things considered, it appears that ULS Technology can comfortably handle its current debt levels. 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for ULS Technology you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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