We Think Rattler Midstream (NASDAQ:RTLR) Is Taking Some Risk With Its Debt

By
Simply Wall St
Published
May 29, 2021
NasdaqGS:RTLR
Source: Shutterstock

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Rattler Midstream LP (NASDAQ:RTLR) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Rattler Midstream

What Is Rattler Midstream's Debt?

As you can see below, at the end of March 2021, Rattler Midstream had US$545.4m of debt, up from US$451.0m a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

debt-equity-history-analysis
NasdaqGS:RTLR Debt to Equity History May 30th 2021

A Look At Rattler Midstream's Liabilities

We can see from the most recent balance sheet that Rattler Midstream had liabilities of US$40.6m falling due within a year, and liabilities of US$561.1m due beyond that. Offsetting these obligations, it had cash of US$9.76m as well as receivables valued at US$53.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$538.6m.

While this might seem like a lot, it is not so bad since Rattler Midstream has a market capitalization of US$1.57b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Rattler Midstream has net debt to EBITDA of 2.5 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 7.5 times its interest expense, and its net debt to EBITDA, was quite high, at 2.5. Importantly, Rattler Midstream's EBIT fell a jaw-dropping 29% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Rattler Midstream 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Rattler Midstream recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Rattler Midstream's EBIT growth rate was disappointing. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Rattler Midstream stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. Case in point: We've spotted 2 warning signs for Rattler Midstream you should be aware of.

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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