Here's Why Ranger Energy Services (NYSE:RNGR) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Ranger Energy Services, Inc. (NYSE:RNGR) 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Ranger Energy Services

What Is Ranger Energy Services's Net Debt?

The image below, which you can click on for greater detail, shows that Ranger Energy Services had debt of US$15.6m at the end of March 2023, a reduction from US$76.7m over a year. However, it does have US$14.4m in cash offsetting this, leading to net debt of about US$1.20m.

How Strong Is Ranger Energy Services' Balance Sheet?

According to the last reported balance sheet, Ranger Energy Services had liabilities of US$67.2m due within 12 months, and liabilities of US$36.1m due beyond 12 months. Offsetting this, it had US$14.4m in cash and US$110.7m in receivables that were due within 12 months. So it actually has US$21.8m more liquid assets than total liabilities.

This surplus suggests that Ranger Energy Services has a conservative balance sheet, and could probably eliminate its debt without much difficulty. But either way, Ranger Energy Services has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). 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).

Ranger Energy Services's net debt to EBITDA ratio is very low, at 0.015, suggesting the debt is only trivial. But EBIT was only 5.4 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. We also note that Ranger Energy Services improved its EBIT from a last year's loss to a positive US$35m. 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 Ranger Energy Services 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Ranger Energy Services actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Ranger Energy Services's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, Ranger Energy Services seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Ranger Energy Services you should know about.

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. 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.