Warren Buffett said: “Volatility is far from synonymous with risk”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Savills plc (LON: SVS) uses debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
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What is Savills’ net debt?
As you can see below, at the end of June 2021, Savills was in debt of £ 374.8million, up from £ 226.2million a year ago. Click on the image for more details. However, his balance sheet shows that he holds £ 481.5million in cash, so he actually has net cash of £ 106.7million.
A look at the responsibilities of Savills
Zooming in on the latest balance sheet data, we can see that Savills had a liability of £ 821.2million due within 12 months and a liability of £ 437.2million beyond. In compensation for these obligations, it had cash of £ 481.5 million as well as receivables valued at £ 456.0 million maturing within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by £ 320.9 million.
Given that Savills has a market cap of £ 1.92 billion, it’s hard to believe these liabilities pose a big threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward. Despite her notable liabilities, Savills has a net cash flow, so it’s fair to say that she doesn’t have a heavy debt load!
The good news is that Savills increased its EBIT by 3.4% year over year, which should allay concerns about debt repayment. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Savills can strengthen its balance sheet over time. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. Savills may have net cash on the balance sheet, but it’s always interesting to see how well the business converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Fortunately for all shareholders, Savills has actually generated more free cash flow than EBIT over the past three years. This kind of solid money conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.
While Savills’ balance sheet is not particularly strong, due to total liabilities it is clearly positive that it has net cash of £ 106.7million. And he impressed us with free cash flow of £ 256million, or 129% of his EBIT. So is Savills debt a risk? It does not seem to us. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. We have identified 2 warning signs with Savills and understanding them should be part of your investment process.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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