We Think Rotork (LON:ROR) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Rotork plc (LON:ROR) does use debt in its business. But is this debt a concern to shareholders?

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 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.

View our latest analysis for Rotork

What Is Rotork's Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Rotork had debt of UK£9.34m, up from UK£837.0k in one year. But on the other hand it also has UK£123.5m in cash, leading to a UK£114.1m net cash position.

How Healthy Is Rotork's Balance Sheet?

The latest balance sheet data shows that Rotork had liabilities of UK£112.6m due within a year, and liabilities of UK£20.0m falling due after that. Offsetting this, it had UK£123.5m in cash and UK£139.6m in receivables that were due within 12 months. So it actually has UK£130.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Rotork could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Rotork boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Rotork has seen its EBIT plunge 13% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Rotork's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Rotork has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Rotork generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Rotork has net cash of UK£114.1m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of UK£65m, being 83% of its EBIT. So is Rotork's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Rotork you should know about.

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.