Costain Group (LON:COST) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Costain Group PLC (LON:COST) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 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. 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.

View our latest analysis for Costain Group

How Much Debt Does Costain Group Carry?

The image below, which you can click on for greater detail, shows that Costain Group had debt of UK£43.0m at the end of June 2021, a reduction from UK£62.0m over a year. However, it does have UK£157.0m in cash offsetting this, leading to net cash of UK£114.0m.

How Healthy Is Costain Group's Balance Sheet?

The latest balance sheet data shows that Costain Group had liabilities of UK£273.4m due within a year, and liabilities of UK£63.5m falling due after that. Offsetting these obligations, it had cash of UK£157.0m as well as receivables valued at UK£221.7m due within 12 months. So it can boast UK£41.8m more liquid assets than total liabilities.

This surplus strongly suggests that Costain Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Costain Group boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that Costain Group improved its EBIT from a last year's loss to a positive UK£18m. 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 Costain 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Costain 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 year, Costain Group saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Costain Group has net cash of UK£114.0m, as well as more liquid assets than liabilities. So we are not troubled with Costain Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Costain Group (of which 2 are significant!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.