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.' 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 TXT e-solutions S.p.A. (BIT:TXT) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
What Is TXT e-solutions's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2021 TXT e-solutions had €63.9m of debt, an increase on €50.9m, over one year. But on the other hand it also has €72.7m in cash, leading to a €8.78m net cash position.
How Healthy Is TXT e-solutions' Balance Sheet?
We can see from the most recent balance sheet that TXT e-solutions had liabilities of €60.0m falling due within a year, and liabilities of €39.1m due beyond that. On the other hand, it had cash of €72.7m and €46.3m worth of receivables due within a year. So it actually has €19.8m more liquid assets than total liabilities.
This surplus suggests that TXT e-solutions is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, TXT e-solutions boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that TXT e-solutions has boosted its EBIT by 57%, thus reducing the spectre of future debt repayments. 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 TXT e-solutions 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While TXT e-solutions 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, TXT e-solutions recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
While we empathize with investors who find debt concerning, you should keep in mind that TXT e-solutions has net cash of €8.78m, as well as more liquid assets than liabilities. And we liked the look of last year's 57% year-on-year EBIT growth. So is TXT e-solutions's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for TXT e-solutions 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.
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.
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