Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Rex Trueform Group Limited (JSE:RTN) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Rex Trueform Group Carry?
As you can see below, Rex Trueform Group had R82.1m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has R110.6m in cash, leading to a R28.5m net cash position.
How Healthy Is Rex Trueform Group's Balance Sheet?
We can see from the most recent balance sheet that Rex Trueform Group had liabilities of R144.1m falling due within a year, and liabilities of R301.9m due beyond that. Offsetting these obligations, it had cash of R110.6m as well as receivables valued at R9.55m due within 12 months. So its liabilities total R325.9m more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of R282.3m, we think shareholders really should watch Rex Trueform Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Rex Trueform Group boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
We also note that Rex Trueform Group improved its EBIT from a last year's loss to a positive R50m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Rex Trueform Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Rex Trueform Group 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. Happily for any shareholders, Rex Trueform Group actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Although Rex Trueform Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R28.5m. And it impressed us with free cash flow of R109m, being 217% of its EBIT. So although we see some areas for improvement, we're not too worried about Rex Trueform Group's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Rex Trueform Group (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.
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.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.