Warren Buffett famously said, '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 CSG Limited (ASX:CSV) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
Check out our latest analysis for CSG
What Is CSG's Net Debt?
The image below, which you can click on for greater detail, shows that CSG had debt of AU$44.7m at the end of June 2019, a reduction from AU$262.6m over a year. However, because it has a cash reserve of AU$26.6m, its net debt is less, at about AU$18.1m.
How Healthy Is CSG's Balance Sheet?
According to the last reported balance sheet, CSG had liabilities of AU$92.2m due within 12 months, and liabilities of AU$196.3m due beyond 12 months. Offsetting these obligations, it had cash of AU$26.6m as well as receivables valued at AU$129.4m due within 12 months. So its liabilities total AU$132.5m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the AU$87.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, CSG 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Given net debt is only 0.77 times EBITDA, it is initially surprising to see that CSG's EBIT has low interest coverage of 1.1 times. So one way or the other, it's clear the debt levels are not trivial. It is well worth noting that CSG's EBIT shot up like bamboo after rain, gaining 77% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if CSG can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.