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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Ruth's Hospitality Group, Inc. (NASDAQ:RUTH) does carry debt. 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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Ruth's Hospitality Group's Net Debt?
As you can see below, Ruth's Hospitality Group had US$70.0m of debt at June 2021, down from US$135.2m a year prior. However, its balance sheet shows it holds US$87.3m in cash, so it actually has US$17.3m net cash.
How Healthy Is Ruth's Hospitality Group's Balance Sheet?
The latest balance sheet data shows that Ruth's Hospitality Group had liabilities of US$110.4m due within a year, and liabilities of US$263.7m falling due after that. Offsetting these obligations, it had cash of US$87.3m as well as receivables valued at US$15.9m due within 12 months. So its liabilities total US$270.8m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Ruth's Hospitality Group has a market capitalization of US$695.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Ruth's Hospitality Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
Better yet, Ruth's Hospitality Group grew its EBIT by 251% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ruth's Hospitality Group'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. Ruth's Hospitality Group 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, Ruth's Hospitality Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While Ruth's Hospitality Group does have more liabilities than liquid assets, it also has net cash of US$17.3m. And it impressed us with free cash flow of US$60m, being 129% of its EBIT. So we don't think Ruth's Hospitality Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Ruth's Hospitality Group has 3 warning signs we think you should be aware of.
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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
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