These 4 measures indicate that Breedon Group (LON:BREE) uses debt safely

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Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Breedon Group plc (LON:BREE) has debt on its balance sheet. But the more important question is: what risk does this debt create?

When is debt a problem?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.

Discover our latest analysis for Breedon Group

What is Breedon Group’s debt?

As you can see below, Breedon Group had a debt of £245.4m in December 2021, up from £295.6m the previous year. However, he also had £83.9m in cash, so his net debt is £161.5m.

AIM:BREE Debt to Equity May 24, 2022

A look at the liabilities of the Breedon group

According to the latest published balance sheet, Breedon Group had liabilities of £279.1m due within 12 months and liabilities of £440.6m due beyond 12 months. On the other hand, it had cash of £83.9 million and £205.9 million of receivables due within a year. It therefore has liabilities totaling £429.9 million more than its cash and short-term receivables combined.

While that might sound like a lot, it’s not too bad since Breedon Group has a market capitalization of £1.16 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Breedon Group’s net debt is only 0.80 times its EBITDA. And its EBIT covers its interest charges 10.8 times. So we’re pretty relaxed about his super-conservative use of debt. On top of that, Breedon Group has increased its EBIT by 85% in the last twelve months, and this growth will make it easier to manage its debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Breedon Group can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Fortunately for all shareholders, Breedon Group has actually produced more free cash flow than EBIT for the past three years. There’s nothing better than incoming money to stay in the good books of your lenders.

Our point of view

Fortunately, Breedon Group’s impressive EBIT to free cash flow conversion means it has the upper hand on its debt. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Zooming out, Breedon Group appears to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. We have identified 2 warning signs with Breedon Group, and understanding them should be part of your investment process.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.

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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