Is Renishaw (LON:RSW) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Renishaw plc (LON:RSW) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Renishaw

How Much Debt Does Renishaw Carry?

The image below, which you can click on for greater detail, shows that Renishaw had debt of UK£6.89m at the end of December 2021, a reduction from UK£11.2m over a year. However, it does have UK£222.0m in cash offsetting this, leading to net cash of UK£215.1m.

How Healthy Is Renishaw's Balance Sheet?

We can see from the most recent balance sheet that Renishaw had liabilities of UK£102.9m falling due within a year, and liabilities of UK£48.4m due beyond that. Offsetting these obligations, it had cash of UK£222.0m as well as receivables valued at UK£145.2m due within 12 months. So it can boast UK£215.9m 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. Simply put, the fact that Renishaw has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Renishaw has boosted its EBIT by 70%, thus reducing the spectre of future debt repayments. 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 Renishaw 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. During the last three years, Renishaw produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. 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£215.1m, as well as more liquid assets than liabilities. And we liked the look of last year's 70% year-on-year EBIT growth. So is Renishaw's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Renishaw's earnings per share history for free.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.