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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Robert Walters plc (LON:RWA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Robert Walters's Debt?
The image below, which you can click on for greater detail, shows that Robert Walters had debt of UK£14.4m at the end of June 2020, a reduction from UK£27.4m over a year. However, its balance sheet shows it holds UK£133.4m in cash, so it actually has UK£119.0m net cash.
A Look At Robert Walters's Liabilities
The latest balance sheet data shows that Robert Walters had liabilities of UK£193.3m due within a year, and liabilities of UK£56.4m falling due after that. On the other hand, it had cash of UK£133.4m and UK£183.9m worth of receivables due within a year. So it actually has UK£67.6m more liquid assets than total liabilities.
It's good to see that Robert Walters has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Robert Walters boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Robert Walters's load is not too heavy, because its EBIT was down 36% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Robert Walters's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Robert Walters has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Robert Walters actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company's debt, in this case Robert Walters has UK£119.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 129% of that EBIT to free cash flow, bringing in UK£87m. So is Robert Walters'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. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Robert Walters has 2 warning signs we think you should be aware of.
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.
This article by Simply Wall St is general in nature. 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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