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. We note that Rapid7, Inc. (NASDAQ:RPD) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Rapid7's Net Debt?
As you can see below, at the end of December 2020, Rapid7 had US$378.6m of debt, up from US$185.2m a year ago. Click the image for more detail. However, it also had US$312.5m in cash, and so its net debt is US$66.1m.
How Strong Is Rapid7's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Rapid7 had liabilities of US$353.7m due within 12 months and liabilities of US$487.9m due beyond that. Offsetting this, it had US$312.5m in cash and US$112.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$416.3m.
Given Rapid7 has a market capitalization of US$4.11b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 Rapid7 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.
In the last year Rapid7 wasn't profitable at an EBIT level, but managed to grow its revenue by 26%, to US$411m. With any luck the company will be able to grow its way to profitability.
Despite the top line growth, Rapid7 still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost US$71m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$15m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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 instance, we've identified 2 warning signs for Rapid7 that you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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