Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Carr's Group plc (LON:CARR) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Carr's Group
What Is Carr's Group's Debt?
The image below, which you can click on for greater detail, shows that Carr's Group had debt of UK£35.4m at the end of February 2021, a reduction from UK£54.8m over a year. However, it also had UK£24.8m in cash, and so its net debt is UK£10.6m.
How Healthy Is Carr's Group's Balance Sheet?
We can see from the most recent balance sheet that Carr's Group had liabilities of UK£82.8m falling due within a year, and liabilities of UK£45.2m due beyond that. On the other hand, it had cash of UK£24.8m and UK£69.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£33.7m.
This deficit isn't so bad because Carr's Group is worth UK£146.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Carr's Group has net debt of just 0.66 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.3 times, which is more than adequate. In fact Carr's Group's saving grace is its low debt levels, because its EBIT has tanked 37% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Carr's Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Carr's Group produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Carr's Group's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. When we consider all the elements mentioned above, it seems to us that Carr's Group is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For instance, we've identified 1 warning sign for Carr's Group that 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.
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About LSE:CARR
Carr's Group
Engages in the agriculture business in the United Kingdom and internationally.
Excellent balance sheet with reasonable growth potential.