We Think Richelieu Hardware (TSE:RCH) Can Manage Its Debt With Ease

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Richelieu Hardware Ltd. (TSE:RCH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Richelieu Hardware

How Much Debt Does Richelieu Hardware Carry?

The image below, which you can click on for greater detail, shows that at February 2022 Richelieu Hardware had debt of CA$42.2m, up from CA$4.41m in one year. But it also has CA$58.7m in cash to offset that, meaning it has CA$16.5m net cash.

A Look At Richelieu Hardware's Liabilities

According to the last reported balance sheet, Richelieu Hardware had liabilities of CA$236.9m due within 12 months, and liabilities of CA$100.9m due beyond 12 months. Offsetting this, it had CA$58.7m in cash and CA$210.0m in receivables that were due within 12 months. So it has liabilities totalling CA$69.1m more than its cash and near-term receivables, combined.

Since publicly traded Richelieu Hardware shares are worth a total of CA$2.01b, it seems unlikely that this level of liabilities would be a major 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, Richelieu Hardware also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Richelieu Hardware has boosted its EBIT by 67%, thus reducing the spectre of future debt repayments. 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 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Over the most recent three years, Richelieu Hardware recorded free cash flow worth 65% 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.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Richelieu Hardware has CA$16.5m in net cash. And we liked the look of last year's 67% year-on-year EBIT growth. So we don't think Richelieu Hardware's use of debt is risky. 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. We've identified 2 warning signs with Richelieu Hardware (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.