Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Crest Nicholson Holdings plc (LON:CRST) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Crest Nicholson Holdings's Net Debt?
As you can see below, Crest Nicholson Holdings had UK£98.3m of debt, at April 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds UK£273.7m in cash, so it actually has UK£175.4m net cash.
How Strong Is Crest Nicholson Holdings' Balance Sheet?
We can see from the most recent balance sheet that Crest Nicholson Holdings had liabilities of UK£550.5m falling due within a year, and liabilities of UK£243.2m due beyond that. On the other hand, it had cash of UK£273.7m and UK£120.0m worth of receivables due within a year. So its liabilities total UK£400.0m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Crest Nicholson Holdings has a market capitalization of UK£700.8m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Crest Nicholson Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, Crest Nicholson Holdings grew its EBIT by 57% over the last twelve months, and that growth will make it easier to handle its debt. 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 Crest Nicholson Holdings 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. Crest Nicholson Holdings 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. Over the last three years, Crest Nicholson Holdings 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.
While Crest Nicholson Holdings does have more liabilities than liquid assets, it also has net cash of UK£175.4m. The cherry on top was that in converted 113% of that EBIT to free cash flow, bringing in UK£77m. So is Crest Nicholson Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Crest Nicholson Holdings .
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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