Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Rank Progress SA (WSE:RNK) has debt on its balance sheet. But the more important question is: what risk does this debt create?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Rank Progress
How much debt does rank progression carry?
As you can see below, Rank Progress had 278.5 million zł in debt in March 2022, compared to 319.1 million zł the previous year. However, since he has a cash reserve of 23.6 million zł, his net debt is lower, at around 254.9 million zł.
How healthy is Rank Progress’ balance sheet?
We can see from the most recent balance sheet that Rank Progress had liabilities of 126.5 million zł due in one year, and liabilities of 269.9 million zł due beyond. In return, it had 23.6 million zł in cash and 72.7 million zł in receivables due within 12 months. Thus, its debts exceed the sum of its cash and (short-term) receivables by 300.1 million zł.
This deficit casts a shadow over the company of 71.9 million zł, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. Ultimately, Rank Progress would likely need a major recapitalization if its creditors were to demand repayment.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Rank Progress shareholders face the double whammy of a high net debt to EBITDA ratio (19.0) and quite low interest coverage, as EBIT is only 1.4 times expenses of interests. The debt burden here is considerable. Worse still, Rank Progress’ EBIT was down 69% from last year. If earnings continue to follow this trajectory, paying off that debt will be harder than convincing us to run a marathon in the rain. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Rank Progress will need income to repay this debt. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Rank Progress has recorded free cash flow of 67% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
To be frank, Rank Progress’ EBIT growth rate and track record of keeping total liabilities under control makes us rather uncomfortable with its level of leverage. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. After reviewing the data points discussed, we believe that Rank Progress has too much debt. That kind of risk is acceptable to some, but it certainly doesn’t float our boat. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To do this, you need to find out about the 3 warning signs we spotted with Rank Progress (including 1 that is significant).
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
Calculation of discounted cash flows for each share
Simply Wall St performs a detailed calculation of discounted cash flow every 6 hours for every stock in the market, so if you want to find the intrinsic value of any company, just search here. It’s free.