TXT e-solutions (BIT:TXT) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that TXT e-solutions S.p.A. (BIT:TXT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for TXT e-solutions

What Is TXT e-solutions's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 TXT e-solutions had €50.9m of debt, an increase on €45.6m, over one year. However, its balance sheet shows it holds €87.9m in cash, so it actually has €37.0m net cash.

How Healthy Is TXT e-solutions's Balance Sheet?

The latest balance sheet data shows that TXT e-solutions had liabilities of €46.5m due within a year, and liabilities of €33.1m falling due after that. Offsetting this, it had €87.9m in cash and €36.7m in receivables that were due within 12 months. So it actually has €45.0m more liquid assets than total liabilities.

This luscious liquidity implies that TXT e-solutions's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that TXT e-solutions has more cash than debt is arguably a good indication that it can manage its debt safely.

Pleasingly, TXT e-solutions is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 153% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine TXT e-solutions's ability to maintain a healthy balance sheet going forward. 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 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 saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that TXT e-solutions has net cash of €37.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 153% year-on-year EBIT growth. So we don't think TXT e-solutions's use of debt is risky. 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. Take risks, for example - TXT e-solutions has 3 warning signs (and 1 which is significant) we think you should know about.

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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