Is Redflex Holdings (ASX:RDF) Using Debt In A Risky Way?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Redflex Holdings Limited (ASX:RDF) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Redflex Holdings

What Is Redflex Holdings's Debt?

As you can see below, at the end of June 2020, Redflex Holdings had AU$19.2m of debt, up from AU$5.88m a year ago. Click the image for more detail. However, it does have AU$22.3m in cash offsetting this, leading to net cash of AU$3.09m.

How Healthy Is Redflex Holdings's Balance Sheet?

We can see from the most recent balance sheet that Redflex Holdings had liabilities of AU$31.8m falling due within a year, and liabilities of AU$34.3m due beyond that. Offsetting these obligations, it had cash of AU$22.3m as well as receivables valued at AU$26.6m due within 12 months. So it has liabilities totalling AU$17.2m more than its cash and near-term receivables, combined.

Redflex Holdings has a market capitalization of AU$57.8m, 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. While it does have liabilities worth noting, Redflex Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Redflex Holdings'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.

In the last year Redflex Holdings had a loss before interest and tax, and actually shrunk its revenue by 14%, to AU$101m. We would much prefer see growth.

So How Risky Is Redflex Holdings?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Redflex Holdings lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of AU$8.5m and booked a AU$10m accounting loss. But at least it has AU$3.09m on the balance sheet to spend on growth, near-term. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. To that end, you should be aware of the 2 warning signs we've spotted with Redflex Holdings .

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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