Is ADF Group (TSE:DRX) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, ADF Group Inc. (TSE:DRX) does carry debt. But should shareholders be worried about its use of debt?

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What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is ADF Group's Debt?

The image below, which you can click on for greater detail, shows that ADF Group had debt of CA$43.1m at the end of October 2024, a reduction from CA$45.2m over a year. But it also has CA$65.5m in cash to offset that, meaning it has CA$22.4m net cash.

How Healthy Is ADF Group's Balance Sheet?

We can see from the most recent balance sheet that ADF Group had liabilities of CA$86.1m falling due within a year, and liabilities of CA$58.8m due beyond that. Offsetting this, it had CA$65.5m in cash and CA$109.1m in receivables that were due within 12 months. So it can boast CA$29.7m more liquid assets than total liabilities.

This surplus suggests that ADF Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, ADF Group boasts net cash, so it's fair to say it does not have a heavy debt load!

View our latest analysis for ADF Group

In addition to that, we're happy to report that ADF Group has boosted its EBIT by 97%, thus reducing the spectre of future debt repayments. 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 ADF Group'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. ADF Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, ADF Group recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that ADF Group has net cash of CA$22.4m, as well as more liquid assets than liabilities. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in CA$76m. So we don't think ADF Group's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of ADF Group's earnings per share history for free.

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

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 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.