Is Rawlplug (WSE:RWL) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Rawlplug S.A. (WSE:RWL) does use debt in its business. 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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Rawlplug

How Much Debt Does Rawlplug Carry?

The chart below, which you can click on for greater detail, shows that Rawlplug had zł281.1m in debt in September 2020; about the same as the year before. However, it also had zł50.6m in cash, and so its net debt is zł230.5m.

How Healthy Is Rawlplug's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Rawlplug had liabilities of zł290.2m due within 12 months and liabilities of zł212.2m due beyond that. Offsetting these obligations, it had cash of zł50.6m as well as receivables valued at zł179.4m due within 12 months. So its liabilities total zł272.4m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of zł326.1m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Rawlplug's net debt to EBITDA ratio of about 2.5 suggests only moderate use of debt. And its strong interest cover of 10.0 times, makes us even more comfortable. Also relevant is that Rawlplug has grown its EBIT by a very respectable 25% in the last year, thus enhancing its ability to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Rawlplug will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Rawlplug's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Rawlplug's ability to to grow its EBIT and its interest cover gave us comfort that it can handle its debt. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about Rawlplug's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Rawlplug , and understanding them should be part of your investment process.

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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