Restaurant Brands International Limited Partnership (TSE:QSP.UN) Has A Somewhat Strained Balance Sheet

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 Restaurant Brands International Limited Partnership (TSE:QSP.UN) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Restaurant Brands International Limited Partnership

How Much Debt Does Restaurant Brands International Limited Partnership Carry?

As you can see below, Restaurant Brands International Limited Partnership had US$13.2b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$895.0m in cash offsetting this, leading to net debt of about US$12.3b.

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

We can see from the most recent balance sheet that Restaurant Brands International Limited Partnership had liabilities of US$1.83b falling due within a year, and liabilities of US$17.4b due beyond that. Offsetting these obligations, it had cash of US$895.0m as well as receivables valued at US$593.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$17.7b.

This is a mountain of leverage even relative to its gargantuan market capitalization of US$17.8b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 5.8, it's fair to say Restaurant Brands International Limited Partnership does have a significant amount of debt. However, its interest coverage of 3.8 is reasonably strong, which is a good sign. However, one redeeming factor is that Restaurant Brands International Limited Partnership grew its EBIT at 20% over the last 12 months, boosting its ability to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Restaurant Brands International Limited Partnership will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Restaurant Brands International Limited Partnership's struggle handle its debt, based on its EBITDA, had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its conversion of EBIT to free cash flow was refreshing. We think that Restaurant Brands International Limited Partnership's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. We've identified 2 warning signs with Restaurant Brands International Limited Partnership (at least 1 which is potentially serious) , 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.