We Think Richelieu Hardware (TSE:RCH) Can Stay On Top Of Its Debt

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 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 can see that Richelieu Hardware Ltd. (TSE:RCH) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Richelieu Hardware

What Is Richelieu Hardware's Debt?

The image below, which you can click on for greater detail, shows that Richelieu Hardware had debt of CA$42.8m at the end of August 2024, a reduction from CA$45.7m over a year. However, its balance sheet shows it holds CA$47.7m in cash, so it actually has CA$4.89m net cash.

How Strong Is Richelieu Hardware's Balance Sheet?

According to the last reported balance sheet, Richelieu Hardware had liabilities of CA$257.3m due within 12 months, and liabilities of CA$189.6m due beyond 12 months. Offsetting these obligations, it had cash of CA$47.7m as well as receivables valued at CA$245.1m due within 12 months. So its liabilities total CA$154.2m more than the combination of its cash and short-term receivables.

Of course, Richelieu Hardware has a market capitalization of CA$2.12b, so these liabilities are probably manageable. 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.

The modesty of its debt load may become crucial for Richelieu Hardware if management cannot prevent a repeat of the 27% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Richelieu Hardware can strengthen its balance sheet over time. 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. In the last three years, Richelieu Hardware's free cash flow amounted to 47% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Richelieu Hardware's liabilities, but we can be reassured by the fact it has has net cash of CA$4.89m. So we don't have any problem with Richelieu Hardware's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Richelieu Hardware .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.