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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Renewable Energy Group, Inc. (NASDAQ:REGI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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?
As you can see below, Renewable Energy Group had US$65.8m of debt at September 2020, down from US$209.4m a year prior. But it also has US$285.6m in cash to offset that, meaning it has US$219.8m net cash.
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$232.2m falling due within a year, and liabilities of US$44.0m due beyond that. Offsetting this, it had US$285.6m in cash and US$207.2m in receivables that were due within 12 months. So it actually has US$216.6m 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. Succinctly put, Renewable Energy Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Renewable Energy Group made a loss at the EBIT level, last year, it was also good to see that it generated US$627m in EBIT over the last twelve months. 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're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Renewable Energy Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Renewable Energy Group recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that Renewable Energy Group has net cash of US$219.8m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$526m, being 84% of its EBIT. So is Renewable Energy Group's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Renewable Energy Group that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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