These 4 Measures Indicate That Rai Way (BIT:RWAY) Is Using Debt Reasonably Well

Simply Wall St · 10/18 04:51

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 can see that Rai Way S.p.A. (BIT:RWAY) does use debt in its business. 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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Rai Way

What Is Rai Way's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Rai Way had €122.6m of debt, an increase on €106.8m, over one year. However, it does have €9.23m in cash offsetting this, leading to net debt of about €113.4m.

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BIT:RWAY Debt to Equity History October 18th 2024

How Strong Is Rai Way's Balance Sheet?

The latest balance sheet data shows that Rai Way had liabilities of €149.1m due within a year, and liabilities of €141.2m falling due after that. On the other hand, it had cash of €9.23m and €78.2m worth of receivables due within a year. So it has liabilities totalling €202.9m more than its cash and near-term receivables, combined.

Since publicly traded Rai Way shares are worth a total of €1.50b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Rai Way has a low net debt to EBITDA ratio of only 0.72. And its EBIT covers its interest expense a whopping 27.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that Rai Way grew its EBIT by 12% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Rai Way'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Rai Way produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Rai Way's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, Rai Way seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Rai Way (of which 1 is potentially serious!) you should know about.

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.