These 4 measures indicate that Eleco (LON: ELCO) uses debt safely
Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it can be obvious that you need to factor in debt, when you think about how risky a given stock is, because too much debt can sink a business. We can see that Eleco Plc (LON: ELCO) uses debt in its business. But does this debt worry shareholders?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, many companies use debt to finance growth without any negative consequences. When we look at debt levels, we first look at cash and debt levels, together.
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How much is Eleco’s debt?
You can click on the graph below for historical figures, but it shows Eleco owed £ 4.51million in debt as of December 2020, up from £ 6.14million a year earlier. But he also has £ 10.7million in cash to make up for that, meaning he has a net cash of £ 6.15million in the UK.
How strong is Eleco’s balance sheet?
We can see from the most recent balance sheet that Eleco had liabilities of £ 12.9million due in one year, and liabilities of £ 6.18million due beyond. On the other hand, he had £ 10.7million in cash and £ 3.56million in receivables due within one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of £ 4.84 million.
Given that Eleco has a market capitalization of £ 98.6million in the UK, it is hard to believe that these liabilities pose a significant threat. Having said that, it is clear that we must continue to monitor his record lest it get worse. Despite its notable liabilities, Eleco has a net cash flow, so it’s fair to say that it doesn’t have a heavy debt!
Fortunately, Eleco increased its EBIT by 9.4% last year, which makes this debt even more manageable. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Eleco can strengthen its balance sheet over time. So if you are focused on the future you can check free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits do not reduce it. Eleco may have net cash on the balance sheet, but it is always interesting to see the extent to which the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Over the past three years, Eleco has actually produced more free cash flow than EBIT. This kind of big cash conversion turns us on as much as the crowd when the beat drops at a Daft Punk concert.
While it always makes sense to look at a company’s total liabilities, it is very reassuring that Eleco has £ 6.15million in net cash. And that impressed us with free cash flow of £ 5.4million, or 108% of its EBIT. So is Eleco’s debt a risk? It does not seem to us. We would be very happy to see if Eleco insiders bought any shares. If you are too, click this link now to take a (free) look at our list of reported insider trades.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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