Grafton Group (LON:GFTU) Has A Rock Solid Balance Sheet

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Grafton Group plc (LON:GFTU) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Grafton Group

What Is Grafton Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Grafton Group had UK£256.6m of debt in December 2021, down from UK£274.1m, one year before. But it also has UK£844.7m in cash to offset that, meaning it has UK£588.0m net cash.

How Strong Is Grafton Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Grafton Group had liabilities of UK£578.7m due within 12 months and liabilities of UK£655.0m due beyond that. Offsetting this, it had UK£844.7m in cash and UK£233.7m in receivables that were due within 12 months. So it has liabilities totalling UK£155.3m more than its cash and near-term receivables, combined.

Of course, Grafton Group has a market capitalization of UK£2.09b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Grafton Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Grafton Group grew its EBIT by 59% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Grafton Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Grafton Group 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, Grafton Group 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

While it is always sensible to look at a company's total liabilities, it is very reassuring that Grafton Group has UK£588.0m in net cash. And it impressed us with free cash flow of UK£195m, being 108% of its EBIT. So we don't think Grafton Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Grafton Group (including 1 which is significant) .

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.