David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Cortina Holdings Limited (SGX:C41) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Cortina Holdings
What Is Cortina Holdings's Debt?
You can click the graphic below for the historical numbers, but it shows that Cortina Holdings had S$15.7m of debt in September 2019, down from S$31.5m, one year before. However, it does have S$79.9m in cash offsetting this, leading to net cash of S$64.2m.
How Healthy Is Cortina Holdings's Balance Sheet?
The latest balance sheet data shows that Cortina Holdings had liabilities of S$80.3m due within a year, and liabilities of S$37.6m falling due after that. Offsetting these obligations, it had cash of S$79.9m as well as receivables valued at S$20.5m due within 12 months. So it has liabilities totalling S$17.5m more than its cash and near-term receivables, combined.
Since publicly traded Cortina Holdings shares are worth a total of S$198.7m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Cortina Holdings 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 Cortina Holdings has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Cortina Holdings'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, a company can only pay off debt with cold hard cash, not accounting profits. While Cortina Holdings 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, Cortina Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Cortina Holdings has S$64.2m in net cash. The cherry on top was that in converted 174% of that EBIT to free cash flow, bringing in S$84m. So is Cortina Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Cortina Holdings you should be aware of, and 1 of them shouldn't be ignored.
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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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