Is Richelieu Hardware (TSE:RCH) A Risky Investment?

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. We note that Richelieu Hardware Ltd. (TSE:RCH) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Richelieu Hardware

What Is Richelieu Hardware's Net Debt?

The image below, which you can click on for greater detail, shows that Richelieu Hardware had debt of CA$5.99m at the end of August 2020, a reduction from CA$7.01m over a year. But it also has CA$74.5m in cash to offset that, meaning it has CA$68.5m net cash.

How Strong Is Richelieu Hardware's Balance Sheet?

According to the last reported balance sheet, Richelieu Hardware had liabilities of CA$142.9m due within 12 months, and liabilities of CA$63.6m due beyond 12 months. Offsetting these obligations, it had cash of CA$74.5m as well as receivables valued at CA$155.1m due within 12 months. So it actually has CA$23.1m 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 while it's hard to imagine that the CA$1.84b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Richelieu Hardware boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Richelieu Hardware grew its EBIT at 16% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Richelieu Hardware'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. 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 produced sturdy free cash flow equating to 76% 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

While it is always sensible to investigate a company's debt, in this case Richelieu Hardware has CA$68.5m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in CA$124m. So is Richelieu Hardware's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Richelieu Hardware would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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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This article by Simply Wall St is general in nature. 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.
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