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'. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Dart Group PLC (LON:DTG) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Dart Group's Net Debt?
As you can see below, at the end of September 2019, Dart Group had UK£981.3m of debt, up from UK£937.4m a year ago. Click the image for more detail. But it also has UK£1.66b in cash to offset that, meaning it has UK£674.4m net cash.
How Strong Is Dart Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Dart Group had liabilities of UK£1.42b due within 12 months and liabilities of UK£1.17b due beyond that. Offsetting this, it had UK£1.66b in cash and UK£235.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£691.2m.
While this might seem like a lot, it is not so bad since Dart Group has a market capitalization of UK£2.80b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Dart Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
The modesty of its debt load may become crucial for Dart Group if management cannot prevent a repeat of the 21% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dart 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Dart 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. In the last three years, Dart Group's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While Dart Group does have more liabilities than liquid assets, it also has net cash of UK£674.4m. So although we see some areas for improvement, we're not too worried about Dart Group's balance sheet. 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. For example, we've discovered 3 warning signs for Dart Group that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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