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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 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. As with many other companies. Redrow plc (LON:RDW) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Redrow
What Is Redrow's Net Debt?
The image below, which you can click on for greater detail, shows that Redrow had debt of UK£1.00m at the end of December 2018, a reduction from UK£84.0m over a year. However, it does have UK£102.0m in cash offsetting this, leading to net cash of UK£101.0m.
How Healthy Is Redrow's Balance Sheet?
The latest balance sheet data shows that Redrow had liabilities of UK£736.0m due within a year, and liabilities of UK£157.0m falling due after that. Offsetting this, it had UK£102.0m in cash and UK£43.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£748.0m.
This deficit isn't so bad because Redrow is worth UK£1.87b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Given that Redrow has more cash than debt, we're pretty confident it can manage its debt safely.
Also good is that Redrow grew its EBIT at 12% over the last year, further increasing its ability to manage debt. 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 Redrow'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. Redrow may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Redrow recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Summing up
Although Redrow's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£101m. On top of that, it increased its EBIT by 12% in the last twelve months. So we are not troubled with Redrow's debt use. Given Redrow has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.