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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. 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. As with many other companies Reckitt Benckiser Group plc (LON:RB.) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Reckitt Benckiser Group
What Is Reckitt Benckiser Group's Net Debt?
As you can see below, Reckitt Benckiser Group had UK£12.3b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. On the flip side, it has UK£1.71b in cash leading to net debt of about UK£10.6b.
A Look At Reckitt Benckiser Group's Liabilities
Zooming in on the latest balance sheet data, we can see that Reckitt Benckiser Group had liabilities of UK£8.99b due within 12 months and liabilities of UK£15.1b due beyond that. Offsetting these obligations, it had cash of UK£1.71b as well as receivables valued at UK£2.14b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£20.3b.
Reckitt Benckiser Group has a very large market capitalization of UK£46.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.