Speedy Hire (LON:SDY) seems to be using debt quite wisely

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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, Quick Hire Plc (LON:SDY) is in debt. But the more important question is: what risk does this debt create?

Why is debt risky?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

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What is Speedy Hire’s debt?

As you can see below, at the end of March 2022, Speedy Hire had a debt of £70.0m, up from £44.9m a year ago. Click on the image for more details. However, as he has a cash reserve of £2.50m, his net debt is lower at around £67.5m.

LSE: SDY Debt to Equity History September 2, 2022

How strong is Speedy Hire’s balance sheet?

We can see from the most recent balance sheet that Speedy Hire had liabilities of £122.7m due within a year, and liabilities of £136.6m due beyond. On the other hand, it had cash of £2.50 million and £102.3 million of receivables due within the year. Thus, its liabilities outweigh the sum of its cash and (current) receivables of £154.5 million.

This is a mountain of leverage compared to its market capitalization of £187.3m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Looking at its net debt to EBITDA of 0.89 and its interest coverage of 5.5x, it seems to us that Speedy Hire is probably using debt quite sensibly. But the interest payments are certainly enough to make us think about the affordability of its debt. Above all, Speedy Hire has increased its EBIT by 51% in the last twelve months, and this growth will make it easier to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Speedy Hire can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Speedy Hire has actually produced more free cash flow than EBIT. There’s nothing better than incoming money to stay in the good books of your lenders.

Our point of view

The good news is that Speedy Hire’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But truth be told, we think his total passive level undermines that impression a bit. Given all of this data, it seems to us that Speedy Hire is taking a pretty sensible approach to debt. This means they take on a bit more risk, hoping to increase shareholder returns. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Speedy Hire you should know.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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