Is Topps Tiles (LON:TPT) Using Debt Sensibly?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Topps Tiles Plc (LON:TPT) does use debt in its business. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Topps Tiles

What Is Topps Tiles's Net Debt?

The image below, which you can click on for greater detail, shows that Topps Tiles had debt of UK£4.98m at the end of September 2020, a reduction from UK£29.9m over a year. But on the other hand it also has UK£31.0m in cash, leading to a UK£26.0m net cash position.

How Healthy Is Topps Tiles's Balance Sheet?

The latest balance sheet data shows that Topps Tiles had liabilities of UK£90.5m due within a year, and liabilities of UK£100.5m falling due after that. Offsetting this, it had UK£31.0m in cash and UK£2.86m in receivables that were due within 12 months. So its liabilities total UK£157.2m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's UK£109.2m 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. Given that Topps Tiles has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Topps Tiles can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Topps Tiles had a loss before interest and tax, and actually shrunk its revenue by 12%, to UK£193m. We would much prefer see growth.

So How Risky Is Topps Tiles?

Although Topps Tiles had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of UK£44m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. 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. For example, we've discovered 1 warning sign for Topps Tiles that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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