Is RELX (LON:REL) A Risky Investment?

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 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 can see that RELX PLC (LON:REL) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 RELX

What Is RELX's Net Debt?

As you can see below, at the end of December 2022, RELX had UK£6.55b of debt, up from UK£5.96b a year ago. Click the image for more detail. However, because it has a cash reserve of UK£334.0m, its net debt is less, at about UK£6.21b.

How Healthy Is RELX's Balance Sheet?

We can see from the most recent balance sheet that RELX had liabilities of UK£5.19b falling due within a year, and liabilities of UK£6.89b due beyond that. On the other hand, it had cash of UK£334.0m and UK£2.10b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£9.65b.

RELX has a very large market capitalization of UK£47.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

We'd say that RELX's moderate net debt to EBITDA ratio ( being 2.3), indicates prudence when it comes to debt. And its commanding EBIT of 13.0 times its interest expense, implies the debt load is as light as a peacock feather. We note that RELX grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if RELX can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, RELX generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

RELX's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think RELX's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. To that end, you should be aware of the 2 warning signs we've spotted with RELX .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.