Is Caledonian Trust (LON:CNN) using too much debt?

Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, Caledonian Trust PLC (LON:CNN) is in debt. But the real question is whether this debt makes the business risky.

What risk does debt carry?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.

Discover our latest analysis for Caledonian Trust

What is Caledonian Trust’s debt?

The image below, which you can click on for more details, shows Caledonian Trust had £4.38million in debt at the end of December 2021, a reduction from £4.95million on a year. On the other hand, he has £2.32m in cash, resulting in a net debt of around £2.06m.

OBJECTIVE: CNN’s Debt to Equity History June 7, 2022

A look at the liabilities of Caledonian Trust

According to the latest published balance sheet, Caledonian Trust had liabilities of £1.08million due within 12 months and liabilities of £4.02million due beyond 12 months. In compensation for these obligations, it had cash of £2.32 million as well as receivables valued at £121.0k and due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of £2.66 million.

Given that publicly traded Caledonian Trust shares are worth a total of £17.7m, it seems unlikely that this level of liability is a major threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Caledonian Trust that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Given that it has no significant operating income at the moment, shareholders are hoping Caledonian Trust can make progress and get better traction for the business, before it runs out of cash.

Caveat Emptor

Over the past twelve months, Caledonian Trust has recorded a loss in earnings before interest and tax (EBIT). To be precise, the EBIT loss amounted to UK£146,000. Considering that alongside the liabilities mentioned above, this doesn’t give us much confidence that the company should use so much debt. Quite frankly, we think the track record falls short, although it could improve over time. On the positive side, we note that trailing twelve month EBIT is worse than free cash flow of £1.7m and profit of £591,000. So you could say that there is still a chance that this could put things on the right track. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, Caledonian Trust has 4 warning signs (and 1 that makes us a little uneasy) we think you should know.

If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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.

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