Yahoo Finance Here's Why Spectris (LON:SXS) Can Manage Its Debt Responsibly
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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Spectris plc (LON:SXS) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Spectris
What Is Spectris's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Spectris had UK£192.7m of debt in June 2020, down from UK£383.0m, one year before. But on the other hand it also has UK£287.0m in cash, leading to a UK£94.3m net cash position.
How Healthy Is Spectris's Balance Sheet?
According to the last reported balance sheet, Spectris had liabilities of UK£451.2m due within 12 months, and liabilities of UK£210.6m due beyond 12 months. Offsetting these obligations, it had cash of UK£287.0m as well as receivables valued at UK£302.2m due within 12 months. So it has liabilities totalling UK£72.6m more than its cash and near-term receivables, combined.
Given Spectris has a market capitalization of UK£2.86b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Spectris also has more cash than debt, so we're pretty confident it can manage its debt safely.
In fact Spectris's saving grace is its low debt levels, because its EBIT has tanked 22% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Spectris'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. While Spectris 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. Over the last three years, Spectris actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Spectris has UK£94.3m in net cash. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in UK£183m. So we don't have any problem with Spectris's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Spectris has 1 warning sign we think you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
This article by Simply Wall St is general in nature. 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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