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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Renishaw plc (LON:RSW) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
How Much Debt Does Renishaw Carry?
As you can see below, at the end of December 2020, Renishaw had UK£11.2m of debt, up from UK£10.7m a year ago. Click the image for more detail. But on the other hand it also has UK£186.6m in cash, leading to a UK£175.4m net cash position.
How Healthy Is Renishaw's Balance Sheet?
According to the last reported balance sheet, Renishaw had liabilities of UK£91.4m due within 12 months, and liabilities of UK£79.9m due beyond 12 months. Offsetting this, it had UK£186.6m in cash and UK£124.3m in receivables that were due within 12 months. So it actually has UK£139.7m more liquid assets than total liabilities.
This surplus suggests that Renishaw has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Renishaw boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Renishaw grew its EBIT by 53% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Renishaw's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Renishaw 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 most recent three years, Renishaw recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Renishaw has UK£175.4m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 53% over the last year. So is Renishaw's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Renishaw that you should be aware of.
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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