Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Above all, Tyman plc (LON: TYMN) is in debt. But should shareholders be concerned about its use of debt?

What risk does debt entail?

Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. 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 painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.

See our latest review for Tyman

How much debt does Tyman have?

As you can see below, Tyman was in debt of £ 156.1million in June 2021, up from £ 238.9million the year before. On the flip side, he has £ 61.1million in cash, resulting in net debt of around £ 95.0million.

Is Tyman’s track record healthy?

According to the latest published balance sheet, Tyman had a liability of £ 152.5million due within 12 months and a liability of £ 201.5million due beyond 12 months. On the other hand, he had £ 61.1million in cash and £ 83.8million in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by £ 209.1 million.

This deficit is not that big as Tyman is worth £ 759.4million and could therefore probably raise enough capital to consolidate his balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Tyman has net debt of only 0.84 times EBITDA, indicating that he is certainly not a reckless borrower. And this view is supported by the strong interest coverage, with EBIT reaching 8.3 times last year’s interest expense. On top of that, Tyman has increased its EBIT by 42% over the past twelve months, and this growth will make it easier to process its debt. There is no doubt that we learn the most about debt from the balance sheet. But it’s future profits, more than anything, that will determine Tyman’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.

Finally, a business can only pay off its debts with hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Tyman has actually generated more free cash flow than EBIT. This kind of solid silver generation warms our hearts like a puppy in a bumblebee costume.

Our point of view

Fortunately, Tyman’s impressive conversion of EBIT to free cash flow means he has the upper hand over his debt. And that’s just the start of good news as its EBIT growth rate is also very encouraging. Looking at the big picture, we think Tyman’s use of debt looks very reasonable and we don’t care. After all, reasonable leverage can increase returns on equity. Over time, stock prices tend to follow earnings per share, so if you are interested in Tyman you may want to click here to view an interactive chart of its historical earnings per share.

At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.

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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 any stock 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 any of the stocks mentioned.