David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, Rai Way S.p.A. (BIT:RWAY) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
See our latest analysis for Rai Way
What Is Rai Way's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2021 Rai Way had €69.2m of debt, an increase on €15.4m, over one year. However, it also had €17.2m in cash, and so its net debt is €52.0m.
How Strong Is Rai Way's Balance Sheet?
The latest balance sheet data shows that Rai Way had liabilities of €102.2m due within a year, and liabilities of €119.9m falling due after that. On the other hand, it had cash of €17.2m and €72.3m worth of receivables due within a year. So its liabilities total €132.6m more than the combination of its cash and short-term receivables.
Since publicly traded Rai Way shares are worth a total of €1.58b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Rai Way's net debt is only 0.37 times its EBITDA. And its EBIT easily covers its interest expense, being 75.4 times the size. So we're pretty relaxed about its super-conservative use of debt. Rai Way's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Rai Way'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Rai Way produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Our View
The good news is that Rai Way's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Taking all this data into account, it seems to us that Rai Way takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Rai Way 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.
About BIT:RWAY
Rai Way
Owns and operates television and radio transmission and broadcasting networks in Italy and internationally.
Outstanding track record, undervalued and pays a dividend.