These 4 Measures Indicate That Rainbow Chicken (JSE:RBO) Is Using Debt Safely

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 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 Rainbow Chicken Limited (JSE:RBO) makes use of debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Rainbow Chicken

What Is Rainbow Chicken's Net Debt?

The image below, which you can click on for greater detail, shows that Rainbow Chicken had debt of R337.8m at the end of December 2024, a reduction from R3.75b over a year. But it also has R970.8m in cash to offset that, meaning it has R633.0m net cash.

How Healthy Is Rainbow Chicken's Balance Sheet?

We can see from the most recent balance sheet that Rainbow Chicken had liabilities of R2.85b falling due within a year, and liabilities of R757.7m due beyond that. On the other hand, it had cash of R970.8m and R2.74b worth of receivables due within a year. So it actually has R96.5m more liquid assets than total liabilities.

This surplus suggests that Rainbow Chicken has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Rainbow Chicken has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Rainbow Chicken grew its EBIT by 1,125% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Rainbow Chicken'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Rainbow Chicken 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. Over the last two years, Rainbow Chicken actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Rainbow Chicken has net cash of R633.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of R1.0b, being 144% of its EBIT. So we don't think Rainbow Chicken's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Rainbow Chicken's earnings per share history for free.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.