The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies EBOS Group Limited (NZSE:EBO) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does EBOS Group Carry?
You can click the graphic below for the historical numbers, but it shows that EBOS Group had AU$271.1m of debt in December 2021, down from AU$612.7m, one year before. However, it does have AU$494.0m in cash offsetting this, leading to net cash of AU$222.9m.
How Healthy Is EBOS Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that EBOS Group had liabilities of AU$1.96b due within 12 months and liabilities of AU$634.5m due beyond that. Offsetting this, it had AU$494.0m in cash and AU$1.28b in receivables that were due within 12 months. So it has liabilities totalling AU$823.3m more than its cash and near-term receivables, combined.
Since publicly traded EBOS Group shares are worth a total of AU$6.88b, 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, EBOS Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
And we also note warmly that EBOS Group grew its EBIT by 12% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine EBOS Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. EBOS 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 most recent three years, EBOS Group recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While EBOS Group does have more liabilities than liquid assets, it also has net cash of AU$222.9m. So is EBOS Group's debt a risk? It doesn't seem so to us. 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. Be aware that EBOS Group is showing 1 warning sign in our investment analysis , you should know about...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.