RBC Bearings (NASDAQ:ROLL) Seems To Use Debt Quite Sensibly

Simply Wall St
March 17, 2022
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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, RBC Bearings Incorporated (NASDAQ:ROLL) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for RBC Bearings

What Is RBC Bearings's Net Debt?

As you can see below, at the end of January 2022, RBC Bearings had US$1.79b of debt, up from US$20.5m a year ago. Click the image for more detail. However, it also had US$255.5m in cash, and so its net debt is US$1.53b.

NasdaqGS:ROLL Debt to Equity History March 17th 2022

How Healthy Is RBC Bearings' Balance Sheet?

We can see from the most recent balance sheet that RBC Bearings had liabilities of US$343.0m falling due within a year, and liabilities of US$2.20b due beyond that. Offsetting this, it had US$255.5m in cash and US$204.3m in receivables that were due within 12 months. So its liabilities total US$2.08b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because RBC Bearings is worth US$5.57b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 8.3, it's fair to say RBC Bearings does have a significant amount of debt. However, its interest coverage of 4.9 is reasonably strong, which is a good sign. We saw RBC Bearings grow its EBIT by 6.7% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to 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 RBC Bearings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, RBC Bearings generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Based on what we've seen RBC Bearings is not finding it easy, given its net debt to EBITDA, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that RBC Bearings is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Be aware that RBC Bearings is showing 4 warning signs in our investment analysis , and 1 of those is concerning...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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