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Here's Why Centrica (LON:CNA) Has A Meaningful Debt Burden

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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.' 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 Centrica plc (LON:CNA) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Centrica

How Much Debt Does Centrica Carry?

The image below, which you can click on for greater detail, shows that Centrica had debt of UK£3.68b at the end of June 2021, a reduction from UK£4.61b over a year. But on the other hand it also has UK£3.73b in cash, leading to a UK£54.0m net cash position.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Centrica's Liabilities

Zooming in on the latest balance sheet data, we can see that Centrica had liabilities of UK£6.88b due within 12 months and liabilities of UK£7.23b due beyond that. On the other hand, it had cash of UK£3.73b and UK£2.61b worth of receivables due within a year. So it has liabilities totalling UK£7.76b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the UK£3.42b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Centrica would probably need a major re-capitalization if its creditors were to demand repayment. Centrica boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

On top of that, Centrica grew its EBIT by 48% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Centrica 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 Centrica 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, Centrica recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While Centrica does have more liabilities than liquid assets, it also has net cash of UK£54.0m. And it impressed us with its EBIT growth of 48% over the last year. So while Centrica does not have a great balance sheet, it's certainly not too bad. 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. Case in point: We've spotted 2 warning signs for Centrica you should be aware of.

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.

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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