Here's Why Renewi (LON:RWI) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Renewi plc (LON:RWI) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Renewi

How Much Debt Does Renewi Carry?

The image below, which you can click on for greater detail, shows that Renewi had debt of €589.8m at the end of September 2020, a reduction from €692.5m over a year. On the flip side, it has €144.8m in cash leading to net debt of about €445.0m.

How Healthy Is Renewi's Balance Sheet?

The latest balance sheet data shows that Renewi had liabilities of €615.7m due within a year, and liabilities of €1.16b falling due after that. Offsetting this, it had €144.8m in cash and €257.5m in receivables that were due within 12 months. So it has liabilities totalling €1.37b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €296.1m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Renewi would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Renewi's debt is 2.5 times its EBITDA, and its EBIT cover its interest expense 4.4 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Pleasingly, Renewi is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 170% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Renewi'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, while the tax-man may adore accounting profits, lenders only accept 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, Renewi recorded free cash flow worth 67% 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

Neither Renewi's ability to handle its total liabilities nor its interest cover gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Renewi's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. For example, we've discovered 1 warning sign for Renewi that you should be aware of before investing here.

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.

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