Warren Buffett famously said, '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. We can see that Ruth's Hospitality Group, Inc. (NASDAQ:RUTH) does use debt in its business. But the more important question is: how much risk is that debt creating?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Ruth's Hospitality Group Carry?
As you can see below, Ruth's Hospitality Group had US$40.0m of debt at June 2022, down from US$70.0m a year prior. But on the other hand it also has US$44.9m in cash, leading to a US$4.87m net cash position.
How Healthy Is Ruth's Hospitality Group's Balance Sheet?
We can see from the most recent balance sheet that Ruth's Hospitality Group had liabilities of US$114.9m falling due within a year, and liabilities of US$258.2m due beyond that. Offsetting these obligations, it had cash of US$44.9m as well as receivables valued at US$34.3m due within 12 months. So its liabilities total US$294.0m more than the combination of its cash and short-term receivables.
Ruth's Hospitality Group has a market capitalization of US$610.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Ruth's Hospitality Group boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Ruth's Hospitality Group grew its EBIT by 74% 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 ultimately the future profitability of the business will decide if Ruth's Hospitality 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Ruth's Hospitality 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 three years, Ruth's Hospitality Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While Ruth's Hospitality Group does have more liabilities than liquid assets, it also has net cash of US$4.87m. The cherry on top was that in converted 106% of that EBIT to free cash flow, bringing in US$24m. So we don't think Ruth's Hospitality Group's use of debt is risky. 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 - Ruth's Hospitality Group has 1 warning sign we think 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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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