We Think Transpaco (JSE:TPC) Can Stay On Top Of Its Debt

By
Simply Wall St
Published
December 22, 2021
JSE:TPC
Source: Shutterstock

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.' 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 can see that Transpaco Limited (JSE:TPC) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Transpaco

What Is Transpaco's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Transpaco had debt of R68.9m, up from R8.05m in one year. But on the other hand it also has R77.6m in cash, leading to a R8.72m net cash position.

debt-equity-history-analysis
JSE:TPC Debt to Equity History December 22nd 2021

How Healthy Is Transpaco's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Transpaco had liabilities of R349.4m due within 12 months and liabilities of R227.8m due beyond that. On the other hand, it had cash of R77.6m and R318.2m worth of receivables due within a year. So it has liabilities totalling R181.3m more than its cash and near-term receivables, combined.

Transpaco has a market capitalization of R489.2m, so it could very likely raise cash to ameliorate 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, Transpaco also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, Transpaco grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Transpaco will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Transpaco 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. In the last three years, Transpaco's free cash flow amounted to 48% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Transpaco's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R8.72m. And it impressed us with its EBIT growth of 21% over the last year. So we are not troubled with Transpaco's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Transpaco is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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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