Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Balfour Beatty plc (LON:BBY) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Balfour Beatty's Net Debt?
As you can see below, Balfour Beatty had UK£710.0m of debt at December 2019, down from UK£768.0m a year prior. But on the other hand it also has UK£778.0m in cash, leading to a UK£68.0m net cash position.
A Look At Balfour Beatty's Liabilities
According to the last reported balance sheet, Balfour Beatty had liabilities of UK£2.35b due within 12 months, and liabilities of UK£1.11b due beyond 12 months. Offsetting these obligations, it had cash of UK£778.0m as well as receivables valued at UK£1.27b due within 12 months. So its liabilities total UK£1.42b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of UK£1.68b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Balfour Beatty boasts net cash, so it's fair to say it does not have a heavy debt load!
We note that Balfour Beatty grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. 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 Balfour Beatty'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Balfour Beatty 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. During the last three years, Balfour Beatty burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While Balfour Beatty does have more liabilities than liquid assets, it also has net cash of UK£68.0m. And we liked the look of last year's 22% year-on-year EBIT growth. So while Balfour Beatty does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Balfour Beatty has 2 warning signs we think you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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. Thank you for reading.