Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Resideo Technologies, Inc. (NYSE:REZI) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Resideo Technologies
What Is Resideo Technologies's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2022 Resideo Technologies had US$1.42b of debt, an increase on US$1.23b, over one year. However, it does have US$349.0m in cash offsetting this, leading to net debt of about US$1.07b.
How Strong Is Resideo Technologies' Balance Sheet?
We can see from the most recent balance sheet that Resideo Technologies had liabilities of US$1.55b falling due within a year, and liabilities of US$2.31b due beyond that. On the other hand, it had cash of US$349.0m and US$1.00b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.51b.
This is a mountain of leverage relative to its market capitalization of US$2.75b. 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.
Resideo Technologies has a low net debt to EBITDA ratio of only 1.4. And its EBIT covers its interest expense a whopping 12.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Resideo Technologies has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. 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 Resideo Technologies can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Resideo Technologies recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
When it comes to the balance sheet, the standout positive for Resideo Technologies was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. For example, its level of total liabilities makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about Resideo Technologies's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. For instance, we've identified 2 warning signs for Resideo Technologies (1 is potentially serious) you should be aware of.
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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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 NYSE:REZI
Resideo Technologies
Develops, manufactures, and sells comfort, energy management, and safety and security solutions to the commercial and residential end markets in the United States, Europe, and internationally.
Very undervalued with adequate balance sheet.