These 4 Measures Indicate That Driver Group (LON:DRV) Is Using Debt Safely

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. We note that Driver Group plc (LON:DRV) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Driver Group

How Much Debt Does Driver Group Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Driver Group had debt of UK£3.00m, up from UK£2.13m in one year. But on the other hand it also has UK£11.2m in cash, leading to a UK£8.22m net cash position.

How Strong Is Driver Group's Balance Sheet?

We can see from the most recent balance sheet that Driver Group had liabilities of UK£13.6m falling due within a year, and liabilities of UK£1.04m due beyond that. Offsetting these obligations, it had cash of UK£11.2m as well as receivables valued at UK£17.8m due within 12 months. So it can boast UK£14.4m more liquid assets than total liabilities.

This luscious liquidity implies that Driver Group's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Driver Group has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Driver Group has seen its EBIT plunge 10% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Driver Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Driver 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. Happily for any shareholders, Driver Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Driver Group has UK£8.22m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 116% of that EBIT to free cash flow, bringing in UK£4.7m. So we don't think Driver Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Driver Group is showing 3 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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