Stock Analysis

Is Reckitt Benckiser Group (LON:RKT) Using Too Much Debt?

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LSE:RKT
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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.' 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. As with many other companies Reckitt Benckiser Group plc (LON:RKT) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Reckitt Benckiser Group

What Is Reckitt Benckiser Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Reckitt Benckiser Group had UK£9.58b of debt in June 2022, down from UK£10.3b, one year before. On the flip side, it has UK£1.29b in cash leading to net debt of about UK£8.30b.

debt-equity-history-analysis
LSE:RKT Debt to Equity History September 26th 2022

How Strong Is Reckitt Benckiser Group's Balance Sheet?

We can see from the most recent balance sheet that Reckitt Benckiser Group had liabilities of UK£7.94b falling due within a year, and liabilities of UK£12.1b due beyond that. Offsetting these obligations, it had cash of UK£1.29b as well as receivables valued at UK£2.38b due within 12 months. So its liabilities total UK£16.4b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Reckitt Benckiser Group is worth a massive UK£42.9b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Reckitt Benckiser Group's moderate net debt to EBITDA ratio ( being 2.4), indicates prudence when it comes to debt. And its commanding EBIT of 15.3 times its interest expense, implies the debt load is as light as a peacock feather. Reckitt Benckiser Group grew its EBIT by 7.8% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Reckitt Benckiser Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Reckitt Benckiser Group recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Reckitt Benckiser Group's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. All these things considered, it appears that Reckitt Benckiser Group can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Reckitt Benckiser Group that you should be aware of.

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.

Valuation is complex, but we're helping make it simple.

Find out whether Reckitt Benckiser Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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About LSE:RKT

Reckitt Benckiser Group

Reckitt Benckiser Group plc manufactures and sells health, hygiene, and nutrition products in the United Kingdom, the United States, China, India, and internationally.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation5
Future Growth3
Past Performance2
Financial Health2
Dividends5

Read more about these checks in the individual report sections or in our analysis model.

Undervalued established dividend payer.