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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. Importantly, LSL Property Services plc (LON:LSL) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is LSL Property Services's Net Debt?
As you can see below, LSL Property Services had UK£5.87m of debt at June 2021, down from UK£37.5m a year prior. However, it does have UK£17.0m in cash offsetting this, leading to net cash of UK£11.2m.
A Look At LSL Property Services' Liabilities
Zooming in on the latest balance sheet data, we can see that LSL Property Services had liabilities of UK£87.9m due within 12 months and liabilities of UK£30.3m due beyond that. On the other hand, it had cash of UK£17.0m and UK£40.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£60.6m.
Of course, LSL Property Services has a market capitalization of UK£460.6m, so these liabilities are probably manageable. 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, LSL Property Services also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that LSL Property Services has boosted its EBIT by 57%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if LSL Property Services 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. LSL Property Services 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. Happily for any shareholders, LSL Property Services actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Although LSL Property Services's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£11.2m. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in UK£28m. So is LSL Property Services's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with LSL Property Services (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.
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. 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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