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.' 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. Importantly, Renishaw plc (LON:RSW) does carry debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Renishaw

What Is Renishaw's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Renishaw had UK£5.89m of debt in December 2022, down from UK£6.89m, one year before. But on the other hand it also has UK£211.5m in cash, leading to a UK£205.6m net cash position.

How Strong Is Renishaw's Balance Sheet?

The latest balance sheet data shows that Renishaw had liabilities of UK£101.8m due within a year, and liabilities of UK£44.2m falling due after that. On the other hand, it had cash of UK£211.5m and UK£167.2m worth of receivables due within a year. So it actually has UK£232.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Renishaw could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Renishaw boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Renishaw saw its EBIT decline by 5.6% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Renishaw 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, a company can only pay off debt with cold hard cash, not accounting profits. While Renishaw has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Renishaw recorded free cash flow worth 60% 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

While we empathize with investors who find debt concerning, you should keep in mind that Renishaw has net cash of UK£205.6m, as well as more liquid assets than liabilities. So we don't think Renishaw's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Renishaw, you may well want to click here to check an interactive graph of its earnings per share history.

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. 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.