Is Balfour Beatty (LON:BBY) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Balfour Beatty plc (LON:BBY) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Balfour Beatty

How Much Debt Does Balfour Beatty Carry?

As you can see below, Balfour Beatty had UK£490.0m of debt at December 2021, down from UK£564.0m a year prior. However, it does have UK£1.03b in cash offsetting this, leading to net cash of UK£543.0m.

How Strong Is Balfour Beatty's Balance Sheet?

We can see from the most recent balance sheet that Balfour Beatty had liabilities of UK£2.40b falling due within a year, and liabilities of UK£1.07b due beyond that. Offsetting these obligations, it had cash of UK£1.03b as well as receivables valued at UK£1.03b due within 12 months. So it has liabilities totalling UK£1.41b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of UK£1.67b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Balfour Beatty also has more cash than debt, so we're pretty confident it can manage its debt safely.

Unfortunately, Balfour Beatty's EBIT flopped 11% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. Happily for any shareholders, Balfour Beatty actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although Balfour Beatty's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£543.0m. The cherry on top was that in converted 516% of that EBIT to free cash flow, bringing in UK£316m. 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. Case in point: We've spotted 2 warning signs for Balfour Beatty 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.