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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies S4 Capital plc (LON:SFOR) makes use of debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does S4 Capital Carry?
The image below, which you can click on for greater detail, shows that at December 2020 S4 Capital had debt of UK£90.4m, up from UK£42.4m in one year. However, it does have UK£142.1m in cash offsetting this, leading to net cash of UK£51.6m.
How Healthy Is S4 Capital's Balance Sheet?
We can see from the most recent balance sheet that S4 Capital had liabilities of UK£292.0m falling due within a year, and liabilities of UK£157.4m due beyond that. On the other hand, it had cash of UK£142.1m and UK£181.4m worth of receivables due within a year. So it has liabilities totalling UK£126.0m more than its cash and near-term receivables, combined.
Given S4 Capital has a market capitalization of UK£2.90b, 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, S4 Capital also has more cash than debt, so we're pretty confident it can manage its debt safely.
Pleasingly, S4 Capital is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 151% gain in the last twelve months. 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 S4 Capital 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While S4 Capital 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 two years, S4 Capital actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
We could understand if investors are concerned about S4 Capital's liabilities, but we can be reassured by the fact it has has net cash of UK£51.6m. And it impressed us with free cash flow of UK£54m, being 221% of its EBIT. So is S4 Capital's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for S4 Capital that 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. 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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