Is Rectifier Technologies (ASX:RFT) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Rectifier Technologies Limited (ASX:RFT) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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.

View our latest analysis for Rectifier Technologies

What Is Rectifier Technologies's Net Debt?

The chart below, which you can click on for greater detail, shows that Rectifier Technologies had AU$2.49m in debt in December 2022; about the same as the year before. But it also has AU$7.89m in cash to offset that, meaning it has AU$5.40m net cash.

How Strong Is Rectifier Technologies' Balance Sheet?

According to the last reported balance sheet, Rectifier Technologies had liabilities of AU$12.6m due within 12 months, and liabilities of AU$3.65m due beyond 12 months. On the other hand, it had cash of AU$7.89m and AU$5.99m worth of receivables due within a year. So it has liabilities totalling AU$2.33m more than its cash and near-term receivables, combined.

Given Rectifier Technologies has a market capitalization of AU$82.5m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Rectifier Technologies also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Rectifier Technologies grew its EBIT by 940% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Rectifier Technologies will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Rectifier Technologies 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. During the last three years, Rectifier Technologies produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Rectifier Technologies's liabilities, but we can be reassured by the fact it has has net cash of AU$5.40m. And we liked the look of last year's 940% year-on-year EBIT growth. So is Rectifier Technologies's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Rectifier Technologies you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.