These 4 Measures Indicate That Reliance Worldwide (ASX:RWC) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Reliance Worldwide Corporation Limited (ASX:RWC) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Reliance Worldwide

How Much Debt Does Reliance Worldwide Carry?

As you can see below, Reliance Worldwide had US$450.2m of debt at June 2023, down from US$576.6m a year prior. However, it does have US$16.6m in cash offsetting this, leading to net debt of about US$433.5m.

A Look At Reliance Worldwide's Liabilities

We can see from the most recent balance sheet that Reliance Worldwide had liabilities of US$194.4m falling due within a year, and liabilities of US$632.8m due beyond that. Offsetting these obligations, it had cash of US$16.6m as well as receivables valued at US$271.3m due within 12 months. So it has liabilities totalling US$539.3m more than its cash and near-term receivables, combined.

Reliance Worldwide has a market capitalization of US$1.91b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Reliance Worldwide has net debt worth 1.7 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.5 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly Reliance Worldwide's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. 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 Reliance Worldwide's ability to maintain a healthy balance sheet going forward. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Reliance Worldwide recorded free cash flow worth 63% 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.

Our View

When it comes to the balance sheet, the standout positive for Reliance Worldwide was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren't so encouraging. For example, its level of total liabilities makes us a little nervous about its debt. Considering this range of data points, we think Reliance Worldwide is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Reliance Worldwide you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.