Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, The Quarto Group, Inc. (LON:QRT) does carry 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. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Quarto Group
What Is Quarto Group's Debt?
As you can see below, Quarto Group had US$72.7m of debt at June 2019, down from US$78.3m a year prior. However, it also had US$7.69m in cash, and so its net debt is US$65.0m.
A Look At Quarto Group's Liabilities
According to the last reported balance sheet, Quarto Group had liabilities of US$59.8m due within 12 months, and liabilities of US$82.7m due beyond 12 months. Offsetting this, it had US$7.69m in cash and US$42.1m in receivables that were due within 12 months. So its liabilities total US$92.7m more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the US$16.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Quarto Group would likely require a major re-capitalisation if it had to pay its creditors today.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.