The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Rosslyn Data Technologies plc (LON:RDT) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Rosslyn Data Technologies's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of April 2019 Rosslyn Data Technologies had UK£1.59m of debt, an increase on UK£1.07m, over one year. But on the other hand it also has UK£1.96m in cash, leading to a UK£373.0k net cash position.
How Strong Is Rosslyn Data Technologies's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Rosslyn Data Technologies had liabilities of UK£4.95m due within 12 months and liabilities of UK£997.0k due beyond that. Offsetting this, it had UK£1.96m in cash and UK£1.80m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£2.19m.
Since publicly traded Rosslyn Data Technologies shares are worth a total of UK£14.0m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Rosslyn Data Technologies boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Rosslyn Data Technologies 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.
In the last year Rosslyn Data Technologies wasn't profitable at an EBIT level, but managed to grow its revenue by8.3%, to UK£7.0m. We usually like to see faster growth from unprofitable companies, but each to their own.
So How Risky Is Rosslyn Data Technologies?
While Rosslyn Data Technologies lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow UK£840k. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Rosslyn Data Technologies insider transactions.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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