Is Retractable Technologies (NYSEMKT:RVP) Using Too Much Debt?

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 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. As with many other companies Retractable Technologies, Inc. (NYSEMKT:RVP) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Retractable Technologies

What Is Retractable Technologies's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Retractable Technologies had US$3.79m of debt, an increase on US$2.73m, over one year. However, its balance sheet shows it holds US$22.4m in cash, so it actually has US$18.6m net cash.

How Healthy Is Retractable Technologies' Balance Sheet?

According to the last reported balance sheet, Retractable Technologies had liabilities of US$14.8m due within 12 months, and liabilities of US$13.2m due beyond 12 months. Offsetting these obligations, it had cash of US$22.4m as well as receivables valued at US$16.0m due within 12 months. So it actually has US$10.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Retractable Technologies could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Retractable Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Retractable Technologies grew its EBIT by 1,785% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Retractable Technologies's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Retractable Technologies may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last two years, Retractable Technologies basically broke even on a free cash flow basis. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing up

While it is always sensible to investigate a company's debt, in this case Retractable Technologies has US$18.6m in net cash and a decent-looking balance sheet. And we liked the look of last year's 1,785% year-on-year EBIT growth. So is Retractable Technologies's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Retractable Technologies you should be aware of, and 1 of them is a bit unpleasant.

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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