Resolute Forest Products (NYSE:RFP) Has A Somewhat Strained Balance Sheet

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.' 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. As with many other companies Resolute Forest Products Inc. (NYSE:RFP) makes use of debt. But should shareholders be worried about its use of debt?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Resolute Forest Products

What Is Resolute Forest Products's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Resolute Forest Products had US$296.0m of debt in June 2021, down from US$621.0m, one year before. On the flip side, it has US$177.0m in cash leading to net debt of about US$119.0m.

How Healthy Is Resolute Forest Products' Balance Sheet?

We can see from the most recent balance sheet that Resolute Forest Products had liabilities of US$532.0m falling due within a year, and liabilities of US$1.91b due beyond that. Offsetting this, it had US$177.0m in cash and US$344.0m in receivables that were due within 12 months. So its liabilities total US$1.92b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$973.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Resolute Forest Products would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Resolute Forest Products's net debt is only 0.13 times its EBITDA. And its EBIT easily covers its interest expense, being 28.4 times the size. So we're pretty relaxed about its super-conservative use of debt. Although Resolute Forest Products made a loss at the EBIT level, last year, it was also good to see that it generated US$767m in EBIT over the last twelve months. 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 Resolute Forest Products 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Resolute Forest Products generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

We feel some trepidation about Resolute Forest Products's difficulty level of total liabilities, but we've got positives to focus on, too. To wit both its interest cover and conversion of EBIT to free cash flow were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Resolute Forest Products is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For example Resolute Forest Products has 3 warning signs (and 1 which is potentially serious) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.
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