Card Factory (LON:CARD) has a somewhat strained balance sheet
Warren Buffett said: “Volatility is far from synonymous with risk. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that plc card factory (LON:CARD) uses debt in its business. But should shareholders worry about its use of debt?
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Card Factory
What is Card Factory’s net debt?
As you can see below, Card Factory had a debt of £111.0m in January 2022, up from £120.3m the previous year. However, he also had £38.5m in cash, so his net debt is £72.5m.
How healthy is Card Factory’s balance sheet?
We can see from the most recent balance sheet that Card Factory had liabilities of £152.2m due within a year, and liabilities of £164.2m due beyond. As compensation for these obligations, it had cash of £38.5 million as well as receivables valued at £3.00 million maturing within 12 months. It therefore has liabilities totaling £274.9 million more than its cash and short-term receivables, combined.
Given that this deficit is actually greater than the company’s market capitalization of £193.4m, we think shareholders really should be watching Card Factory’s debt levels, like a parent watching their child do cycling for the first time. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
While Card Factory has a fairly reasonable net debt to EBITDA ratio of 1.9, its interest coverage looks low at 1.5. This suggests that the company is paying quite high interest rates. Regardless, there is no doubt that the stock uses significant leverage. We also note that Card Factory improved its EBIT from last year’s loss to a positive result of £30m. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Card Factory’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Fortunately for all shareholders, Card Factory has actually produced more free cash flow than EBIT over the past year. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
At first glance, Card Factory’s level of total liabilities left us wondering about the stock, and its interest coverage was no more enticing than the single empty restaurant on the busiest night of the year. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we think the debt makes Card Factory shares a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. Given our hesitation on the stock, it would be nice to know if any Card Factory insiders have been selling shares recently. You click here to find out if insiders have sold recently.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.