Warren Buffett said: “Volatility is far from synonymous with risk”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We can see that RCM Technologies, Inc. (NASDAQ: RCMT) uses debt in its business. But the real question is whether this debt makes the business risky.
When Is Debt a Problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. When we think of a business’s use of debt, we first look at cash flow and debt together.
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What is the debt of RCM Technologies?
You can click on the graph below for historical figures, but it shows RCM Technologies owed US $ 22.0 million in debt in April 2021, up from US $ 32.8 million a year earlier. On the other hand, it has US $ 678.0k in cash, resulting in net debt of approximately US $ 21.4 million.
A look at RCM Technologies’ liabilities
Zooming in on the latest balance sheet data, we can see that RCM Technologies had liabilities of US $ 27.8 million due within 12 months and liabilities of US $ 27.1 million due beyond. In compensation for these obligations, he had cash of US $ 678.0 K as well as receivables valued at US $ 49.2 M due within 12 months. Its liabilities therefore total $ 4.94 million more than the combination of its cash and short-term receivables.
Given that RCM Technologies has a market capitalization of US $ 52.9 million, it is hard to believe that these liabilities pose a significant threat. Having said that, it is clear that we must continue to monitor his record lest it get worse.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
Low interest coverage of 2.2 times and an unusually high Net Debt / EBITDA ratio of 8.1 hit our confidence in RCM Technologies like a punch in the gut. This means that we would consider him to be in heavy debt. A buyout factor for RCM Technologies is that it turned last year’s loss of EBIT into a gain of US $ 1.2 million over the past twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether RCM Technologies can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore important to check to what extent its earnings before interest and taxes (EBIT) translate into actual free cash flow. Fortunately for all shareholders, RCM Technologies has actually generated more free cash flow than EBIT over the past year. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
We were not impressed with RCM Technologies’ interest coverage, and its net debt to EBITDA made us cautious. But its conversion from EBIT to free cash flow paid off considerably. Given this range of data points, we believe RCM Technologies is well positioned to manage its debt levels. But beware: we believe debt levels are high enough to warrant continued monitoring. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. We have identified 3 warning signs with RCM Technologies (at least 1 which is a bit worrying), and understanding them should be part of your investment process.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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