We Think Rank Group (LON:RNK) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies The Rank Group Plc (LON:RNK) makes use of debt. But the real question is whether this debt is making the company risky.

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 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. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that RNK is potentially undervalued!

How Much Debt Does Rank Group Carry?

As you can see below, Rank Group had UK£78.0m of debt at June 2022, down from UK£117.1m a year prior. However, it does have UK£97.9m in cash offsetting this, leading to net cash of UK£19.9m.

How Strong Is Rank Group's Balance Sheet?

According to the last reported balance sheet, Rank Group had liabilities of UK£216.5m due within 12 months, and liabilities of UK£215.1m due beyond 12 months. On the other hand, it had cash of UK£97.9m and UK£42.3m worth of receivables due within a year. So it has liabilities totalling UK£291.4m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of UK£337.3m, so it does suggest shareholders should keep an eye on Rank Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Rank Group boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Rank Group turned things around in the last 12 months, delivering and EBIT of UK£105m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Rank Group 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. Rank Group 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. Happily for any shareholders, Rank Group actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Rank Group'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£19.9m. The cherry on top was that in converted 109% of that EBIT to free cash flow, bringing in UK£115m. So we are not troubled with Rank Group's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Rank Group you should know about.

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.