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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Renewable Energy Group, Inc. (NASDAQ:REGI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Renewable Energy Group's Debt?
The image below, which you can click on for greater detail, shows that Renewable Energy Group had debt of US$43.9m at the end of March 2021, a reduction from US$240.9m over a year. But on the other hand it also has US$466.8m in cash, leading to a US$422.9m net cash position.
A Look At Renewable Energy Group's Liabilities
We can see from the most recent balance sheet that Renewable Energy Group had liabilities of US$194.4m falling due within a year, and liabilities of US$46.6m due beyond that. Offsetting this, it had US$466.8m in cash and US$152.0m in receivables that were due within 12 months. So it can boast US$377.8m more liquid assets than total liabilities.
This short term liquidity is a sign that Renewable Energy Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Renewable Energy Group has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Renewable Energy Group if management cannot prevent a repeat of the 78% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Renewable Energy Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Renewable Energy 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. Over the last three years, Renewable Energy Group recorded free cash flow worth a fulsome 100% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case Renewable Energy Group has US$422.9m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$312m, being 100% of its EBIT. So we don't have any problem with Renewable Energy Group's use of debt. 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 - Renewable Energy Group has 3 warning signs we think you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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