City Service (WSE:CTS) Has A Pretty Healthy Balance Sheet

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, City Service SE (WSE:CTS) does carry debt. But the more important question is: how much risk is that debt creating?

We've discovered 4 warning signs about City Service. View them for free.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

What Is City Service's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2024 City Service had debt of €26.8m, up from €20.4m in one year. However, it does have €4.83m in cash offsetting this, leading to net debt of about €22.0m.

A Look At City Service's Liabilities

The latest balance sheet data shows that City Service had liabilities of €36.7m due within a year, and liabilities of €27.0m falling due after that. On the other hand, it had cash of €4.83m and €45.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €13.3m.

This deficit isn't so bad because City Service is worth €42.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

See our latest analysis for City Service

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

City Service's net debt of 2.3 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.4 times interest expense) certainly does not do anything to dispel this impression. Also relevant is that City Service has grown its EBIT by a very respectable 27% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is City Service's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, City Service recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that City Service's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. And we also thought its interest cover was a positive. Looking at all the aforementioned factors together, it strikes us that City Service can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for City Service (1 is significant) 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.

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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.