Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ 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. Importantly, Franklin Covey Co. (NYSE:FC) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Franklin Covey
How Much Debt Does Franklin Covey Carry?
As you can see below, Franklin Covey had US$20.0m of debt, at August 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has US$27.1m in cash to offset that, meaning it has US$7.14m net cash.
A Look At Franklin Covey’s Liabilities
We can see from the most recent balance sheet that Franklin Covey had liabilities of US$102.5m falling due within a year, and liabilities of US$43.5m due beyond that. Offsetting this, it had US$27.1m in cash and US$56.4m in receivables that were due within 12 months. So its liabilities total US$62.4m more than the combination of its cash and short-term receivables.
Given Franklin Covey has a market capitalization of US$340.6m, 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. Despite its noteworthy liabilities, Franklin Covey boasts net cash, so it’s fair to say it does not have a heavy debt load!
Franklin Covey grew its EBIT by 3.3% in the last year. That’s far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Franklin Covey’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Franklin Covey has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Franklin Covey actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Although Franklin Covey’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$7.14m. And it impressed us with free cash flow of US$26m, being 573% of its EBIT. So we are not troubled with Franklin Covey’s debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. Be aware that Franklin Covey is showing 1 warning sign in our investment analysis , you should know about…
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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