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What does Drax Group plc’s (LON:DRX) Balance Sheet Tell Us About Its Future?

Simply Wall St

Drax Group plc (LON:DRX) is a small-cap stock with a market capitalization of UK£1.5b. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? So, understanding the company’s financial health becomes crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. Though, since I only look at basic financial figures, I’d encourage you to dig deeper yourself into DRX here.

How much cash does DRX generate through its operations?

DRX has sustained its debt level by about UK£608m over the last 12 months including long-term debt. At this current level of debt, DRX currently has UK£289m remaining in cash and short-term investments for investing into the business. On top of this, DRX has generated cash from operations of UK£311m over the same time period, resulting in an operating cash to total debt ratio of 51%, meaning that DRX’s operating cash is sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In DRX’s case, it is able to generate 0.51x cash from its debt capital.

Does DRX’s liquid assets cover its short-term commitments?

At the current liabilities level of UK£1.7b, it seems that the business may not be able to easily meet these obligations given the level of current assets of UK£1.4b, with a current ratio of 0.82x.

LSE:DRX Historical Debt, March 5th 2019

Does DRX face the risk of succumbing to its debt-load?

With a debt-to-equity ratio of 34%, DRX’s debt level may be seen as prudent. DRX is not taking on too much debt commitment, which may be constraining for future growth. We can check to see whether DRX is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In DRX’s, case, the ratio of 3.1x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as DRX’s high interest coverage is seen as responsible and safe practice.

Next Steps:

DRX has demonstrated its ability to generate sufficient levels of cash flow, while its debt hovers at an appropriate level. However, its lack of liquidity raises questions over current asset management practices for the small-cap. This is only a rough assessment of financial health, and I’m sure DRX has company-specific issues impacting its capital structure decisions. You should continue to research Drax Group to get a better picture of the stock by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for DRX’s future growth? Take a look at our free research report of analyst consensus for DRX’s outlook.
  2. Valuation: What is DRX worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether DRX is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.