Yahoo Finance We Think Royal Mail (LON:RMG) Can Stay On Top Of Its Debt
Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Royal Mail plc (LON:RMG) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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.
Check out our latest analysis for Royal Mail
What Is Royal Mail's Net Debt?
As you can see below, at the end of September 2020, Royal Mail had UK£957.0m of debt, up from UK£443.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds UK£1.07b in cash, so it actually has UK£115.0m net cash.
How Healthy Is Royal Mail's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Royal Mail had liabilities of UK£2.61b due within 12 months and liabilities of UK£2.45b due beyond that. Offsetting this, it had UK£1.07b in cash and UK£1.41b in receivables that were due within 12 months. So its liabilities total UK£2.58b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Royal Mail has a market capitalization of UK£4.56b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Royal Mail also has more cash than debt, so we're pretty confident it can manage its debt safely.
Fortunately, Royal Mail grew its EBIT by 7.7% in the last year, making that debt load look even more manageable. 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 Royal Mail 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Royal Mail 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 three years, Royal Mail 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
Although Royal Mail's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£115.0m. The cherry on top was that in converted 110% of that EBIT to free cash flow, bringing in UK£655m. So we don't have any problem with Royal Mail's use of debt. 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. To that end, you should be aware of the 3 warning signs we've spotted with Royal Mail .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
