Ratio Energies – Limited Partnership (TLV:RATI) takes some risk with its use of debt

David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Ratio Energies – Limited partnership (TLV: RATI) has debt on its balance sheet. But the real question is whether this debt makes the business risky.

When is debt a problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.

Discover our latest analyzes for Ratio Energies – Limited Partnership

How much debt does Ratio Energies – Limited Partnership have?

The graph below, which you can click on for more details, shows that Ratio Energies – Limited Partnership had debt of US$822.2 million in March 2022; about the same as the previous year. However, he has $221.7 million in cash to offset this, resulting in a net debt of around $600.5 million.

TASE:RATI Debt to Equity July 6, 2022

How healthy is the balance sheet of Ratio Energies – Limited Partnership?

Zooming in on the latest balance sheet data, we can see that Ratio Energies – Limited Partnership had liabilities of US$171.6 million due within 12 months and liabilities of US$749.0 million due beyond. In compensation for these obligations, it had cash of US$221.7 million as well as receivables valued at US$63.4 million and maturing within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $635.5 million.

This is a mountain of leverage compared to its market capitalization of US$749.7 million. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

The debt of Ratio Energies – Limited Partnership is 2.9 times its EBITDA and its EBIT covers 3.5 times its interest expense. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. On the bright side, Ratio Energies – Limited Partnership has increased its EBIT by 45% over the past year. Like a mother’s loving embrace of a newborn, this kind of growth builds resilience, putting the company in a stronger position to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Ratio Energies – Limited Partnership’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Ratio Energies – Limited Partnership has barely had positive free cash flow, overall. While many businesses operate at breakeven, we’d rather see substantial free cash flow, especially if it’s already dead.

Our point of view

Neither the ability of Ratio Energies – Limited Partnership to convert EBIT into free cash flow nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is that it looks like it could easily increase its EBIT. Considering the above factors, we believe that the debt of Ratio Energies – Limited Partnership poses certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 1 warning sign for Ratio Energies – Limited Partnership of which you should be aware.

If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

Sallie R. Loera