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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, RBC Bearings Incorporated (NASDAQ:ROLL) does carry debt. But the real question is whether this debt is making the company risky.
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is RBC Bearings's Debt?
You can click the graphic below for the historical numbers, but it shows that RBC Bearings had US$16.1m of debt in April 2021, down from US$23.0m, one year before. However, its balance sheet shows it holds US$241.3m in cash, so it actually has US$225.2m net cash.
How Healthy Is RBC Bearings' Balance Sheet?
We can see from the most recent balance sheet that RBC Bearings had liabilities of US$88.2m falling due within a year, and liabilities of US$116.1m due beyond that. Offsetting these obligations, it had cash of US$241.3m as well as receivables valued at US$116.1m due within 12 months. So it actually has US$153.1m more liquid assets than total liabilities.
This short term liquidity is a sign that RBC Bearings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, RBC Bearings boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for RBC Bearings if management cannot prevent a repeat of the 23% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if RBC Bearings 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 company can only pay off debt with cold hard cash, not accounting profits. RBC Bearings 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, RBC Bearings produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case RBC Bearings has US$225.2m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in US$141m. So we don't have any problem with RBC Bearings's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for RBC Bearings that you should be aware of before investing here.
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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