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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that CTS Corporation (NYSE:CTS) 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 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does CTS Carry?
The chart below, which you can click on for greater detail, shows that CTS had US$50.0m in debt in March 2022; about the same as the year before. However, it does have US$126.2m in cash offsetting this, leading to net cash of US$76.2m.
A Look At CTS' Liabilities
The latest balance sheet data shows that CTS had liabilities of US$115.0m due within a year, and liabilities of US$89.5m falling due after that. Offsetting these obligations, it had cash of US$126.2m as well as receivables valued at US$95.1m due within 12 months. So it can boast US$16.7m more liquid assets than total liabilities.
Having regard to CTS' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$1.13b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, CTS boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, CTS grew its EBIT by 52% over the last twelve months, and that growth will make it easier to handle its debt. 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 CTS'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. CTS 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. During the last three years, CTS generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that CTS has net cash of US$76.2m, as well as more liquid assets than liabilities. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in US$68m. So is CTS's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with CTS , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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