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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 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 Clarkson PLC (LON:CKN) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Clarkson
What Is Clarkson's Debt?
The image below, which you can click on for greater detail, shows that Clarkson had debt of UK£3.40m at the end of June 2020, a reduction from UK£6.10m over a year. But it also has UK£173.3m in cash to offset that, meaning it has UK£169.9m net cash.
How Healthy Is Clarkson's Balance Sheet?
We can see from the most recent balance sheet that Clarkson had liabilities of UK£137.9m falling due within a year, and liabilities of UK£70.3m due beyond that. Offsetting these obligations, it had cash of UK£173.3m as well as receivables valued at UK£76.4m due within 12 months. So it can boast UK£41.5m more liquid assets than total liabilities.
This surplus suggests that Clarkson has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Clarkson boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Clarkson grew its EBIT at 14% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Clarkson 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Clarkson 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. During the last three years, Clarkson generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.