Warren Buffett famously said, ‘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. As with many other companies Richelieu Hardware Ltd. (TSE:RCH) makes use of debt. But is this debt a concern to shareholders?
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. 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, 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.
How Much Debt Does Richelieu Hardware Carry?
You can click the graphic below for the historical numbers, but it shows that Richelieu Hardware had CA$4.41m of debt in February 2021, down from CA$11.7m, one year before. But it also has CA$62.4m in cash to offset that, meaning it has CA$58.0m net cash.
A Look At Richelieu Hardware’s Liabilities
According to the last reported balance sheet, Richelieu Hardware had liabilities of CA$138.5m due within 12 months, and liabilities of CA$67.9m due beyond 12 months. Offsetting these obligations, it had cash of CA$62.4m as well as receivables valued at CA$156.1m due within 12 months. So it actually has CA$12.2m more liquid assets than total liabilities.
Having regard to Richelieu Hardware’s size, it seems that its liquid assets are well balanced with its total liabilities. So it’s very unlikely that the CA$2.41b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Richelieu Hardware boasts net cash, so it’s fair to say it does not have a heavy debt load!
Another good sign is that Richelieu Hardware has been able to increase its EBIT by 29% in twelve months, making it easier to pay down 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 Richelieu Hardware 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. Richelieu Hardware 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. During the last three years, Richelieu Hardware generated free cash flow amounting to a very robust 86% of its EBIT, more than we’d 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 Richelieu Hardware has net cash of CA$58.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CA$131m, being 86% of its EBIT. So we don’t think Richelieu Hardware’s use of debt is risky. 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. Case in point: We’ve spotted 1 warning sign for Richelieu Hardware 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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