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 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. As with many other companies Restaurant Brands International Limited Partnership (TSE:QSP.UN) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Restaurant Brands International Limited Partnership

How Much Debt Does Restaurant Brands International Limited Partnership Carry?

The chart below, which you can click on for greater detail, shows that Restaurant Brands International Limited Partnership had US$12.9b in debt in December 2022; about the same as the year before. On the flip side, it has US$1.18b in cash leading to net debt of about US$11.8b.

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

According to the last reported balance sheet, Restaurant Brands International Limited Partnership had liabilities of US$2.12b due within 12 months, and liabilities of US$16.4b due beyond 12 months. Offsetting this, it had US$1.18b in cash and US$614.0m in receivables that were due within 12 months. So its liabilities total US$16.7b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of US$21.2b, so it does suggest shareholders should keep an eye on Restaurant Brands International Limited Partnership's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 5.4, 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. The good news is that Restaurant Brands International Limited Partnership improved its EBIT by 4.9% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Restaurant Brands International Limited Partnership will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Restaurant Brands International Limited Partnership produced sturdy free cash flow equating to 69% 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.

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. In particular, its conversion of EBIT to free cash flow was re-invigorating. Looking at all the angles mentioned above, it does seem to us that Restaurant Brands International Limited Partnership is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Restaurant Brands International Limited Partnership (at least 3 which are a bit concerning) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.