Warren Buffett once said, “Volatility is far from synonymous with risk.” So it may be obvious that you need to factor in debt when you consider how risky a particular stock is, as too much debt can sink a company. We can see that RCM Technologies, Inc. (NASDAQ:RCMT) does use debt in its business. But the real question is whether this debt makes the business risky.
When is debt a problem?
Debt helps a company until the company struggles to pay it off, either with new capital or free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still expensive) situation is that a company has to dilute shareholders at a cheap share price in order to get its debt under control. Of course, many companies use debt to finance growth, with no negative consequences. When we think about a company’s use of debt, let’s first look at cash and debt together.
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Check out our latest analysis for RCM Technologies
How much debt does RCM Technologies have?
You can click on the image below for the historical numbers, but it shows RCM Technologies had $22.0 million in debt in April 2021, up from $32.8 million a year earlier. On the other hand, it has US$678.0k in cash leading to a net debt of approximately US$21.4 million.
A Look at RCM Technologies’ Commitments
If we zoom in on the most recent balance sheet data, we can see that RCM Technologies had liabilities of $27.8 million within 12 months and $27.1 million thereafter. To offset these obligations, the company had USD 678.0k and receivables of USD 49.2 million to be paid within 12 months. So his liabilities total US$4.94 million more than the combination of his cash and receivables.
Given that RCM Technologies has a market cap of $52.9 million, it’s hard to believe that these liabilities pose a major threat. That said, it is clear that we must continue to monitor the balance, so as not to deteriorate.
To upgrade a company’s debt relative to revenue, we calculate net debt divided by revenue before interest, taxes, depreciation, and amortization (EBITDA) and revenue before interest and tax (EBIT) divided by interest expense (are interest coverage). So we consider debt in relation to earnings, both with and without depreciation and amortization costs.
Weak interest coverage of 2.2 times and an alarmingly high net debt to EBITDA ratio of 8.1 hit our confidence in RCM Technologies like a one-two punch. This means we consider it highly indebted. A compensating factor for RCM Technologies is that it turned last year’s EBIT loss in the last 12 months into a profit of $1.2 million. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the future profitability of the company will decide whether RCM Technologies can strengthen its balance sheet over time. So if you want to see what the pros think, you might find this free analyst earnings forecast report be interesting.
Finally, while the tax man loves accounting profits, lenders only accept cold hard cash. So it’s important to check how much of the profit before interest and tax (EBIT) is converted into actual free cash flow. Fortunately for all shareholders, RCM Technologies produced more free cash flow than EBIT in the past year. That kind of strong money generation warms our hearts like a puppy in a bumblebee suit.
We were not impressed with RCM Technologies’ interest coverage and net debt to EBITDA made us cautious. But the conversion from EBIT to free cash flow was significantly redeeming. Given this set of data, we believe RCM Technologies is in a good position to manage its debt levels. But a word of warning: we think debt levels are high enough to warrant continued monitoring. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside within the balance sheet – far from it. We have identified 3 warning signs with RCM Technologies (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.
If you are interested in investing in companies that can make profits without debt, check this out free list of growing companies with net cash on the balance sheet.
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