Renewable Energy Group (NASDAQ:REGI) Seems To Use Debt Quite Sensibly

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.' 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. Importantly, Renewable Energy Group, Inc. (NASDAQ:REGI) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Renewable Energy Group

What Is Renewable Energy Group's Debt?

The image below, which you can click on for greater detail, shows that Renewable Energy Group had debt of US$43.9m at the end of March 2021, a reduction from US$240.9m over a year. But it also has US$466.8m in cash to offset that, meaning it has US$422.9m net cash.

How Healthy Is Renewable Energy Group's Balance Sheet?

We can see from the most recent balance sheet that Renewable Energy Group had liabilities of US$194.4m falling due within a year, and liabilities of US$46.6m due beyond that. Offsetting these obligations, it had cash of US$466.8m as well as receivables valued at US$152.0m due within 12 months. So it actually has US$377.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Renewable Energy Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Renewable Energy Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Renewable Energy Group's saving grace is its low debt levels, because its EBIT has tanked 78% in the last twelve months. 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 Renewable Energy Group 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. While Renewable Energy Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Renewable Energy Group generated free cash flow amounting to a very robust 100% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Renewable Energy Group has net cash of US$422.9m, as well as more liquid assets than liabilities. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in US$312m. So we are not troubled with Renewable Energy Group's debt use. 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. To that end, you should be aware of the 3 warning signs we've spotted with Renewable Energy Group .

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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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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