Here's Why Ratio Energies - Limited Partnership (TLV:RATI) Has A Meaningful Debt Burden

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, Ratio Energies - Limited Partnership (TLV:RATI) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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.

Check out our latest analysis for Ratio Energies - Limited Partnership

What Is Ratio Energies - Limited Partnership's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Ratio Energies - Limited Partnership had US$598.2m of debt in December 2023, down from US$663.2m, one year before. However, because it has a cash reserve of US$153.2m, its net debt is less, at about US$445.1m.

How Strong Is Ratio Energies - Limited Partnership's Balance Sheet?

According to the last reported balance sheet, Ratio Energies - Limited Partnership had liabilities of US$82.8m due within 12 months, and liabilities of US$656.6m due beyond 12 months. Offsetting this, it had US$153.2m in cash and US$72.4m in receivables that were due within 12 months. So its liabilities total US$513.9m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$848.6m, so it does suggest shareholders should keep an eye on Ratio Energies - Limited Partnership's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Ratio Energies - Limited Partnership has net debt worth 1.8 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.0 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Unfortunately, Ratio Energies - Limited Partnership saw its EBIT slide 8.5% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ratio Energies - Limited Partnership's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Ratio Energies - Limited Partnership recorded free cash flow worth 63% 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.

Our View

Neither Ratio Energies - Limited Partnership's ability to grow its EBIT nor its interest cover gave us confidence in its ability to take on more debt. But we do take some comfort from its conversion of EBIT to free cash flow. Looking at all the angles mentioned above, it does seem to us that Ratio Energies - Limited Partnership is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Ratio Energies - Limited Partnership has 2 warning signs we think you should be aware of.

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. 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.