Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that The Restaurant Group plc (LON:RTN) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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.
What Is Restaurant Group's Debt?
As you can see below, at the end of June 2020, Restaurant Group had UK£441.1m of debt, up from UK£346.1m a year ago. Click the image for more detail. However, because it has a cash reserve of UK£132.9m, its net debt is less, at about UK£308.3m.
How Healthy Is Restaurant Group's Balance Sheet?
The latest balance sheet data shows that Restaurant Group had liabilities of UK£257.3m due within a year, and liabilities of UK£1.19b falling due after that. Offsetting these obligations, it had cash of UK£132.9m as well as receivables valued at UK£25.3m due within 12 months. So its liabilities total UK£1.29b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the UK£438.5m 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, Restaurant Group would probably need a major re-capitalization if its creditors were to demand repayment. 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 Restaurant 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.
In the last year Restaurant Group had a loss before interest and tax, and actually shrunk its revenue by 10%, to UK£784m. We would much prefer see growth.
Not only did Restaurant Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost UK£5.8m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through UK£48m in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Restaurant Group (of which 1 is potentially serious!) you should know about.
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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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. 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.
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