Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, Tree House Education & Accessories Limited (NSE:TREEHOUSE) is in debt. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
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How much debt does Tree House Education & Accessories have?
As you can see below, Tree House Education & Accessories had a debt of ₹198.7 million in March 2022, up from ₹334.0 million the previous year. Net debt is about the same, since she doesn’t have a lot of cash.
How healthy is Tree House Education & Accessories’ balance sheet?
According to the latest published balance sheet, Tree House Education & Accessories had liabilities of ₹294.5 million due within 12 months and liabilities of ₹400,000 due beyond 12 months. As compensation for these obligations, he had cash of ₹100.0k as well as receivables valued at ₹250.8 million due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by ₹44.0 million.
Given that the listed Tree House Education & Accessories shares are worth a total of ₹576.3 million, it seems unlikely that this level of liabilities will pose a major threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Tree House Education & Accessories will need income to repay this debt. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
Last year, Tree House Education & Accessories was unprofitable on an EBIT basis, but managed to increase its revenue by 13% to ₹60 million. We generally like to see faster growth from unprofitable businesses, but each in its own way.
It is important to note that Tree House Education & Accessories has recorded a loss of earnings before interest and taxes (EBIT) over the past year. Indeed, it lost a very considerable ₹364 million in EBIT. When we look at this and recall the liabilities on its balance sheet, versus cash, it seems unwise to us that the company has liabilities. So we think its balance sheet is a little stretched, but not beyond repair. Another reason for caution is that it has lost £288m of negative free cash flow over the past twelve months. In short, it’s a really risky title. 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 outside of the balance sheet. We have identified 4 warning signs with Tree House Education & Accessories (at least 3 that are significant), and understanding them should be part of your investment process.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.