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 may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Mostly, RELX-API (LON:REL) is in debt. But the real question is whether this debt makes the business risky.
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
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What is RELX’s debt?
As you can see below, RELX had a debt of £5.97 billion in December 2021, up from £6.85 billion the previous year. And he doesn’t have a lot of cash, so his net debt is about the same.
How strong is RELX’s balance sheet?
Zooming in on the latest balance sheet data, we can see that RELX had liabilities of £3.75bn due within 12 months and liabilities of £6.89bn due beyond. As compensation for these obligations, it had cash of £113.0 million as well as receivables valued at £1.64 billion and due within 12 months. It therefore has liabilities totaling £8.88 billion more than its cash and short-term receivables, combined.
While that might sound like a lot, it’s not that bad since RELX has a huge market capitalization of £43.6 billion, so it could probably bolster its balance sheet by raising capital if needed. However, it is always worth taking a close look at its ability to repay debt.
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). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
RELX’s net debt is 2.7 times its EBITDA, which is significant but still reasonable leverage. But its EBIT was around 15.0 times its interest expense, implying that the company isn’t really paying a high cost to maintain that level of leverage. Even if the low cost turns out to be unsustainable, that’s a good sign. RELX increased its EBIT by 6.4% over the past year. While that barely brings us down, it’s a positive when it comes to debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether RELX can strengthen its balance sheet over time. 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. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, RELX has generated free cash flow of a very strong 82% of its EBIT, more than expected. This puts him in a very strong position to pay off the debt.
Our point of view
Fortunately, RELX’s impressive interest coverage means it has the upper hand on its debt. But truth be told, we think its net debt to EBITDA somewhat undermines that impression. When we consider the range of factors above, it appears that RELX is quite sensitive with its use of debt. While this carries some risk, it can also improve shareholder returns. 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 – RELX has 1 warning sign we think you should know.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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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.