Is the ADF Group (TSE: DRX) in too much debt?
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies ADF Group Inc. (TSE: DRX) uses debt. But the most important question is: what risk does this debt create?
When is debt dangerous?
Debt helps a business until the business struggles to repay it, 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 costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest analysis for the ADF Group
How much debt does ADF Group have?
You can click on the graph below for historical figures, but it shows that ADF Group had C $ 19.2 million in debt in July 2021, up from C $ 25.4 million a year earlier. However, it has C $ 14.3 million in cash offsetting this, leading to net debt of around C $ 4.95 million.
How strong is ADF Group’s balance sheet?
The latest balance sheet data shows that ADF Group had C $ 90.3 million in liabilities due within one year, and C $ 26.4 million in liabilities due thereafter. In compensation for these obligations, it had cash of C $ 14.3 million as well as receivables valued at C $ 98.9 million maturing within 12 months. Its liabilities therefore total C $ 3.57 million more than the combination of its cash and short-term receivables.
Given that ADF Group has a market capitalization of C $ 62.0 million, it is difficult to believe that these liabilities pose a significant threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
ADF Group has a low net debt to EBITDA ratio of just 0.30. And its EBIT easily covers its interest costs, being 10.3 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Even more impressive, the ADF Group increased its EBIT by 584% over twelve months. This boost will make it even easier to pay down debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the results of ADF Group that will influence the balance sheet in the future. So if you want to know more about its profits, it may be worth checking out this chart of its long term profit trend.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, ADF Group has indeed generated more free cash flow than EBIT. This kind of cash conversion makes us as excited as the crowd when the pace drops at a Daft Punk concert.
Our point of view
The conversion of ADF Group’s EBIT to free cash flow suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against a goalkeeper under 14. And that’s just the start of good news as its EBIT growth rate is also very encouraging. We believe that ADF Group is no more indebted to its lenders than the birds are to ornithologists. In our opinion, he has a healthy and happy track record. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. To do this, you need to know the 2 warning signs we spotted with ADF Group.
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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