Is Reach (LON:RCH) A Risky Investment?

By
Simply Wall St
Published
October 27, 2020

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Reach plc (LON:RCH) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Reach

What Is Reach's Net Debt?

As you can see below, Reach had UK£25.0m of debt at June 2020, down from UK£39.7m a year prior. But it also has UK£66.9m in cash to offset that, meaning it has UK£41.9m net cash.

LSE:RCH Debt to Equity History October 27th 2020

A Look At Reach's Liabilities

The latest balance sheet data shows that Reach had liabilities of UK£178.5m due within a year, and liabilities of UK£595.1m falling due after that. Offsetting these obligations, it had cash of UK£66.9m as well as receivables valued at UK£91.9m due within 12 months. So its liabilities total UK£614.8m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the UK£351.1m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Reach would likely require a major re-capitalisation if it had to pay its creditors today. Reach boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

On the other hand, Reach's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Reach 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Reach 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. In the last three years, Reach's free cash flow amounted to 48% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While Reach does have more liabilities than liquid assets, it also has net cash of UK£41.9m. Despite its cash we think that Reach seems to struggle to handle its total liabilities, so we are wary of the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Reach .

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. 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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