Rio Tinto Group (LON:RIO) Could Easily Take On More Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Rio Tinto Group (LON:RIO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Rio Tinto Group

How Much Debt Does Rio Tinto Group Carry?

The chart below, which you can click on for greater detail, shows that Rio Tinto Group had US$12.2b in debt in December 2021; about the same as the year before. But on the other hand it also has US$15.4b in cash, leading to a US$3.18b net cash position.

How Healthy Is Rio Tinto Group's Balance Sheet?

According to the last reported balance sheet, Rio Tinto Group had liabilities of US$12.6b due within 12 months, and liabilities of US$33.7b due beyond 12 months. Offsetting this, it had US$15.4b in cash and US$3.65b in receivables that were due within 12 months. So its liabilities total US$27.3b more than the combination of its cash and short-term receivables.

Rio Tinto Group has a very large market capitalization of US$125.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Rio Tinto Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Rio Tinto Group has boosted its EBIT by 74%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Rio Tinto Group'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Rio Tinto 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. Over the most recent three years, Rio Tinto Group recorded free cash flow worth 62% 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.

Summing up

Although Rio Tinto 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 US$3.18b. And we liked the look of last year's 74% year-on-year EBIT growth. So we don't think Rio Tinto Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Rio Tinto Group is showing 3 warning signs in our investment analysis , and 1 of those is concerning...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.