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 risk.” It is only natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. Like many other companies Bellway plc (LON: BWY) uses debt. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first look at cash and debt levels, together.
See our latest analysis for Bellway
What is Bellway’s net debt?
The image below, which you can click for more details, shows that in July 2021, Bellway was in debt of Â£ 130.0million, up from Â£ 50.0million in a year. But he also has Â£ 460.3million in cash to make up for that, meaning he has Â£ 330.3million in net cash.
Is Bellway’s Balance Sheet Healthy?
Zooming in on the latest balance sheet data, we can see that Bellway had a liability of Â£ 1.07bn due within 12 months and a liability of Â£ 316.9m beyond. On the other hand, he had Â£ 460.3million in cash and Â£ 75.1million worth of receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by Â£ 853.6 million.
While that might sound like a lot, it’s not that big of a deal since Bellway has a market cap of Â£ 4.13 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution. Despite her notable liabilities, Bellway has a net cash flow, so it’s fair to say that she doesn’t have a heavy debt load!
On top of that, Bellway has increased its EBIT by 65% ââover the past twelve months, and this growth will make it easier to process 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 Bellway can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business can only pay off its debts with hard cash, not with book profits. While Bellway has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it’s building (or erodes) that cash balance. . Over the past three years, Bellway has recorded free cash flow of 42% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.
Although Bellway has more liabilities than liquid assets, it also has net cash of Â£ 330.3million. And we liked the appearance of the 65% year-over-year EBIT growth from last year. We therefore do not believe that Bellway’s use of debt is risky. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 2 warning signs for Bellway that you need to be aware of.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.