Tharisa (JSE:THA) Seems To Use Debt Rather Sparingly

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.' 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 note that Tharisa plc (JSE:THA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Tharisa

What Is Tharisa's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Tharisa had US$36.5m of debt in March 2021, down from US$58.7m, one year before. However, its balance sheet shows it holds US$81.9m in cash, so it actually has US$45.4m net cash.

How Strong Is Tharisa's Balance Sheet?

The latest balance sheet data shows that Tharisa had liabilities of US$111.2m due within a year, and liabilities of US$109.4m falling due after that. Offsetting these obligations, it had cash of US$81.9m as well as receivables valued at US$148.0m due within 12 months. So it actually has US$9.37m more liquid assets than total liabilities.

This short term liquidity is a sign that Tharisa could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Tharisa has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Tharisa grew its EBIT by 415% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tharisa can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Tharisa 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. Looking at the most recent three years, Tharisa 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.

Summing up

While it is always sensible to investigate a company's debt, in this case Tharisa has US$45.4m in net cash and a decent-looking balance sheet. And we liked the look of last year's 415% year-on-year EBIT growth. So is Tharisa'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 Tharisa you should be aware of, and 1 of them is a bit concerning.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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