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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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, The RealReal, Inc. (NASDAQ:REAL) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is RealReal's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2020 RealReal had debt of US$147.0m, up from US$6.50m in one year. However, it does have US$410.3m in cash offsetting this, leading to net cash of US$263.3m.
How Healthy Is RealReal's Balance Sheet?
According to the last reported balance sheet, RealReal had liabilities of US$102.6m due within 12 months, and liabilities of US$263.6m due beyond 12 months. Offsetting this, it had US$410.3m in cash and US$6.31m in receivables that were due within 12 months. So it actually has US$50.4m more liquid assets than total liabilities.
This short term liquidity is a sign that RealReal could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that RealReal has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine RealReal's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year RealReal wasn't profitable at an EBIT level, but managed to grow its revenue by 18%, to US$311m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
So How Risky Is RealReal?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year RealReal had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$130m and booked a US$128m accounting loss. However, it has net cash of US$263.3m, so it has a bit of time before it will need more capital. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that RealReal is showing 4 warning signs in our investment analysis , you should know about...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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