Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Computacenter plc (LON:CCC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Computacenter's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Computacenter had UK£121.2m of debt, an increase on UK£80.8m, over one year. But it also has UK£309.8m in cash to offset that, meaning it has UK£188.7m net cash.
How Strong Is Computacenter's Balance Sheet?
We can see from the most recent balance sheet that Computacenter had liabilities of UK£1.59b falling due within a year, and liabilities of UK£184.7m due beyond that. Offsetting this, it had UK£309.8m in cash and UK£1.23b in receivables that were due within 12 months. So it has liabilities totalling UK£229.8m more than its cash and near-term receivables, combined.
Of course, Computacenter has a market capitalization of UK£2.90b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Computacenter boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Computacenter grew its EBIT by 35% over the last twelve months, and that growth will make it easier to handle its debt. 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 Computacenter 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Computacenter has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Computacenter recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Computacenter has UK£188.7m in net cash. And it impressed us with free cash flow of UK£209m, being 95% of its EBIT. So is Computacenter's debt a risk? It doesn't seem so to us. 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 instance, we've identified 2 warning signs for Computacenter (1 makes us a bit uncomfortable) you should be aware of.
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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