Howard Marks put it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the risk level of a business. We note that Marshalls plc (LON: MSLH) has debt on its balance sheet. But should shareholders be concerned about its use of debt?

Why Does Debt Bring Risk?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If things really go wrong, lenders can take over the business. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.

Check out our latest review for Marshalls

What is Marshalls Debt?

As you can see below, Marshalls had £ 60.5million in debt in June 2021, up from £ 139.9million the year before. However, he also had £ 52.3million in cash, so his net debt is £ 8.20million.

How strong is Marshalls’ balance sheet?

The latest balance sheet data shows Marshalls had a liability of £ 175.6million due within one year and a liability of £ 99.9million due after that. In return, he had £ 52.3 million in cash and £ 119.0 million in receivables due within 12 months. His liabilities therefore total £ 104.3million more than the combination of his cash and short-term receivables.

Given that Marshalls has a market cap of £ 1.45 billion, it’s hard to believe these liabilities pose a significant threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward. But anyway, Marshalls has virtually no net debt, so it’s fair to say he doesn’t have a lot of debt!

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Marshalls’ net debt is only 0.10 times its EBITDA. And its EBIT covers its interest costs 13.4 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, Marshalls has increased its EBIT by 63% over the past twelve months, and that growth will make it easier to process its debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Marshalls’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Marshalls has generated strong free cash flow equivalent to 71% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.

Our point of view

Fortunately, Marshalls’ impressive interest coverage means he has the upper hand on his debt. And the good news doesn’t end there, as its EBIT growth rate also supports this impression! Given this array of factors, it seems to us that Marshalls is being fairly conservative with its debt, and the risks appear to be well managed. We are therefore not worried about the use of a small leverage on the balance sheet. Another factor that would give us confidence in Marshalls would be if insiders bought stocks: if you are also aware of this signal, you can find out instantly by clicking this link.

If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow net-growth stocks.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.

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