Is Strix Group (LON:KETL) Using Too Much Debt?

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.' 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 Strix Group Plc (LON:KETL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Strix Group

How Much Debt Does Strix Group Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Strix Group had debt of UK£52.6m, up from UK£40.0m in one year. On the flip side, it has UK£15.4m in cash leading to net debt of about UK£37.2m.

A Look At Strix Group's Liabilities

We can see from the most recent balance sheet that Strix Group had liabilities of UK£33.7m falling due within a year, and liabilities of UK£62.6m due beyond that. On the other hand, it had cash of UK£15.4m and UK£16.8m worth of receivables due within a year. So it has liabilities totalling UK£64.0m more than its cash and near-term receivables, combined.

Given Strix Group has a market capitalization of UK£588.4m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Strix Group's net debt is only 1.1 times its EBITDA. And its EBIT easily covers its interest expense, being 29.3 times the size. So we're pretty relaxed about its super-conservative use of debt. While Strix Group doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Strix Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Strix Group recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Strix Group's impressive interest cover implies it has the upper hand on its debt. And its conversion of EBIT to free cash flow is good too. When we consider the range of factors above, it looks like Strix Group is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Strix Group has 4 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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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