Is Restaurant Brands International Limited Partnership (TSE:QSP.UN) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Restaurant Brands International Limited Partnership (TSE:QSP.UN) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Restaurant Brands International Limited Partnership

What Is Restaurant Brands International Limited Partnership's Debt?

The image below, which you can click on for greater detail, shows that Restaurant Brands International Limited Partnership had debt of US$12.7b at the end of March 2021, a reduction from US$13.4b over a year. However, because it has a cash reserve of US$1.56b, its net debt is less, at about US$11.2b.

How Healthy Is Restaurant Brands International Limited Partnership's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Restaurant Brands International Limited Partnership had liabilities of US$1.55b due within 12 months and liabilities of US$17.3b due beyond that. Offsetting this, it had US$1.56b in cash and US$519.0m in receivables that were due within 12 months. So its liabilities total US$16.8b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of US$22.7b, so it does suggest shareholders should keep an eye on Restaurant Brands International Limited Partnership's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 6.2, it's fair to say Restaurant Brands International Limited Partnership does have a significant amount of debt. However, its interest coverage of 3.1 is reasonably strong, which is a good sign. Investors should also be troubled by the fact that Restaurant Brands International Limited Partnership saw its EBIT drop by 19% over the last twelve months. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. There's no doubt that we learn most about debt from the balance sheet. But it is Restaurant Brands International Limited Partnership's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Restaurant Brands International Limited Partnership recorded free cash flow worth 67% 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

On the face of it, Restaurant Brands International Limited Partnership's EBIT growth rate left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, we think it's fair to say that Restaurant Brands International Limited Partnership has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Restaurant Brands International Limited Partnership (1 can't be ignored!) that you should be aware of before investing here.

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. 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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