We Think Citadel Group (ASX:CGL) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that The Citadel Group Limited (ASX:CGL) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Citadel Group

How Much Debt Does Citadel Group Carry?

The image below, which you can click on for greater detail, shows that at June 2019 Citadel Group had debt of AU$11.5m, up from AU$17.1 in one year. However, its balance sheet shows it holds AU$14.0m in cash, so it actually has AU$2.49m net cash.

ASX:CGL Historical Debt, January 27th 2020
ASX:CGL Historical Debt, January 27th 2020

How Healthy Is Citadel Group's Balance Sheet?

The latest balance sheet data shows that Citadel Group had liabilities of AU$40.1m due within a year, and liabilities of AU$17.2m falling due after that. On the other hand, it had cash of AU$14.0m and AU$37.4m worth of receivables due within a year. So its liabilities total AU$5.90m more than the combination of its cash and short-term receivables.

Given Citadel Group has a market capitalization of AU$233.7m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Citadel Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Citadel Group if management cannot prevent a repeat of the 44% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Citadel Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Citadel Group 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. Over the most recent three years, Citadel Group recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

We could understand if investors are concerned about Citadel Group's liabilities, but we can be reassured by the fact it has has net cash of AU$2.49m. And it impressed us with free cash flow of AU$8.4m, being 67% of its EBIT. So we don't have any problem with Citadel Group's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Citadel Group is showing 2 warning signs in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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