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.' 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 can see that Currys Plc (LON:CURY) does use debt in its business. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Currys's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Currys had UK£5.00m of debt in October 2021, down from UK£71.0m, one year before. However, it does have UK£255.0m in cash offsetting this, leading to net cash of UK£250.0m.
How Strong Is Currys' Balance Sheet?
The latest balance sheet data shows that Currys had liabilities of UK£3.25b due within a year, and liabilities of UK£1.72b falling due after that. Offsetting these obligations, it had cash of UK£255.0m as well as receivables valued at UK£687.0m due within 12 months. So it has liabilities totalling UK£4.02b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the UK£1.34b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Currys would likely require a major re-capitalisation if it had to pay its creditors today. Currys boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
Shareholders should be aware that Currys's EBIT was down 22% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Currys 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Currys 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, Currys actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While Currys does have more liabilities than liquid assets, it also has net cash of UK£250.0m. The cherry on top was that in converted 216% of that EBIT to free cash flow, bringing in UK£367m. Despite its cash we think that Currys seems to struggle to handle its total liabilities, so we are wary of the stock. 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 example - Currys has 2 warning signs we think you should be aware of.
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.