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. Importantly, Travis Perkins plc (LON:TPK) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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.
What Is Travis Perkins's Net Debt?
As you can see below, Travis Perkins had UK£583.2m of debt at June 2019, down from UK£612.3m a year prior. However, it does have UK£139.3m in cash offsetting this, leading to net debt of about UK£443.9m.
A Look At Travis Perkins's Liabilities
Zooming in on the latest balance sheet data, we can see that Travis Perkins had liabilities of UK£1.95b due within 12 months and liabilities of UK£1.77b due beyond that. Offsetting this, it had UK£139.3m in cash and UK£1.02b in receivables that were due within 12 months. So its liabilities total UK£2.56b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of UK£3.66b, so it does suggest shareholders should keep an eye on Travis Perkins's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Travis Perkins can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Travis Perkins wasn't profitable at an EBIT level, but managed to grow its revenue by19%, to UK£6.9b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months Travis Perkins produced an earnings before interest and tax (EBIT) loss. Indeed, it lost UK£52m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Surprisingly, we note that it actually reported positive free cash flow of UK£175m and a profit of UK£74m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Travis Perkins insider transactions.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.