These 4 Measures Indicate That Restaurant Brands International Limited Partnership (TSE:QSP.UN) Is Using Debt Extensively

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Restaurant Brands International Limited Partnership (TSE:QSP.UN) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Restaurant Brands International Limited Partnership

What Is Restaurant Brands International Limited Partnership's Net Debt?

As you can see below, Restaurant Brands International Limited Partnership had US$12.9b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$1.31b, its net debt is less, at about US$11.6b.

How Healthy 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$2.07b due within 12 months, and liabilities of US$16.3b due beyond 12 months. On the other hand, it had cash of US$1.31b and US$692.0m worth of receivables due within a year. So it has liabilities totalling US$16.4b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of US$25.9b, 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With a net debt to EBITDA ratio of 5.0, it's fair to say Restaurant Brands International Limited Partnership does have a significant amount of debt. However, its interest coverage of 3.7 is reasonably strong, which is a good sign. The good news is that Restaurant Brands International Limited Partnership improved its EBIT by 5.1% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 69% 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

Restaurant Brands International Limited Partnership's net debt to EBITDA was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its conversion of EBIT to free cash flow was re-invigorating. We think that Restaurant Brands International Limited Partnership's debt does make it a bit risky, after considering the aforementioned data points together. 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. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Restaurant Brands International Limited Partnership (2 shouldn't be ignored) you should be aware of.

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.

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.