Is Renishaw (LON:RSW) A Risky Investment?

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.' 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 Renishaw plc (LON:RSW) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Renishaw

How Much Debt Does Renishaw Carry?

The image below, which you can click on for greater detail, shows that at June 2020 Renishaw had debt of UK£11.5m, up from UK£10.4m in one year. However, its balance sheet shows it holds UK£120.4m in cash, so it actually has UK£108.8m net cash.

A Look At Renishaw's Liabilities

We can see from the most recent balance sheet that Renishaw had liabilities of UK£93.7m falling due within a year, and liabilities of UK£125.9m due beyond that. Offsetting this, it had UK£120.4m in cash and UK£135.1m in receivables that were due within 12 months. So it can boast UK£35.9m more liquid assets than total liabilities.

This state of affairs indicates that Renishaw's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the UK£4.22b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Renishaw boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Renishaw's load is not too heavy, because its EBIT was down 33% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Renishaw's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Renishaw 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. Looking at the most recent three years, Renishaw recorded free cash flow of 50% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Renishaw has net cash of UK£108.8m, as well as more liquid assets than liabilities. So we don't have any problem with Renishaw's use of debt. 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. Case in point: We've spotted 2 warning signs for Renishaw you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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