Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Reliance, Inc. (NYSE:RS) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Reliance Carry?

The chart below, which you can click on for greater detail, shows that Reliance had US$1.14b in debt in March 2024; about the same as the year before. However, it also had US$934.9m in cash, and so its net debt is US$208.0m.

How Strong Is Reliance's Balance Sheet?

According to the last reported balance sheet, Reliance had liabilities of US$857.4m due within 12 months, and liabilities of US$1.91b due beyond 12 months. On the other hand, it had cash of US$934.9m and US$1.69b worth of receivables due within a year. So it has liabilities totalling US$148.6m more than its cash and near-term receivables, combined.

Having regard to Reliance's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$16.4b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, Reliance has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Reliance's net debt is only 0.11 times its EBITDA. And its EBIT easily covers its interest expense, being 41.6 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Reliance's saving grace is its low debt levels, because its EBIT has tanked 30% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Reliance can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Reliance produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Based on what we've seen Reliance is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that Reliance is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Reliance is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com