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.' 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. Importantly, Proact IT Group AB (publ) (STO:PACT) does carry debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Proact IT Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Proact IT Group had kr151.3m of debt in December 2020, down from kr231.2m, one year before. But on the other hand it also has kr468.3m in cash, leading to a kr317.0m net cash position.
A Look At Proact IT Group's Liabilities
The latest balance sheet data shows that Proact IT Group had liabilities of kr1.47b due within a year, and liabilities of kr853.2m falling due after that. Offsetting these obligations, it had cash of kr468.3m as well as receivables valued at kr1.04b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr806.3m.
This deficit isn't so bad because Proact IT Group is worth kr2.75b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Proact IT Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that Proact IT Group has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Proact IT Group 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. Proact IT Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Proact IT Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While Proact IT Group does have more liabilities than liquid assets, it also has net cash of kr317.0m. And it impressed us with free cash flow of kr199m, being 121% of its EBIT. So is Proact IT Group's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Proact IT Group you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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