Here's Why RAVE Restaurant Group (NASDAQ:RAVE) Can Manage Its Debt Responsibly

By
Simply Wall St
Published
September 14, 2020

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that RAVE Restaurant Group, Inc. (NASDAQ:RAVE) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for RAVE Restaurant Group

How Much Debt Does RAVE Restaurant Group Carry?

The chart below, which you can click on for greater detail, shows that RAVE Restaurant Group had US$1.54m in debt in March 2020; about the same as the year before. However, it does have US$1.54m in cash offsetting this, leading to net debt of about US$7.0k.

NasdaqCM:RAVE Debt to Equity History September 14th 2020

How Strong Is RAVE Restaurant Group's Balance Sheet?

The latest balance sheet data shows that RAVE Restaurant Group had liabilities of US$2.60m due within a year, and liabilities of US$6.22m falling due after that. Offsetting this, it had US$1.54m in cash and US$2.02m in receivables that were due within 12 months. So it has liabilities totalling US$5.3m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of US$6.83m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Carrying virtually no net debt, RAVE Restaurant Group has a very light debt load indeed.

On top of that, RAVE Restaurant Group grew its EBIT by 70% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since RAVE Restaurant Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last two years, RAVE Restaurant Group created free cash flow amounting to 2.5% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

RAVE Restaurant Group's interest cover was a real positive on this analysis, as was its EBIT growth rate. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. When we consider all the elements mentioned above, it seems to us that RAVE Restaurant Group is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for RAVE Restaurant Group (1 doesn't sit too well with us) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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.
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