Renishaw (LON:RSW) Seems To Use Debt Rather Sparingly

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. As with many other companies Renishaw plc (LON:RSW) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

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What Is Renishaw's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Renishaw had UK£6.08m of debt in June 2022, down from UK£7.45m, one year before. However, its balance sheet shows it holds UK£253.2m in cash, so it actually has UK£247.1m net cash.

How Strong Is Renishaw's Balance Sheet?

We can see from the most recent balance sheet that Renishaw had liabilities of UK£132.7m falling due within a year, and liabilities of UK£44.9m due beyond that. Offsetting these obligations, it had cash of UK£253.2m as well as receivables valued at UK£158.8m due within 12 months. So it actually has UK£234.4m more liquid assets than total liabilities.

This surplus suggests that Renishaw has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Renishaw has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Renishaw grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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'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. 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. During the last three years, Renishaw produced sturdy free cash flow equating to 71% 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£247.1m, as well as more liquid assets than liabilities. And we liked the look of last year's 32% year-on-year EBIT growth. So is Renishaw's debt a risk? It doesn't seem so to us. 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.