Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Resideo Technologies, Inc. (NYSE:REZI) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Resideo Technologies Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Resideo Technologies had debt of US$2.00b, up from US$1.41b in one year. On the flip side, it has US$544.0m in cash leading to net debt of about US$1.45b.

A Look At Resideo Technologies' Liabilities

We can see from the most recent balance sheet that Resideo Technologies had liabilities of US$1.67b falling due within a year, and liabilities of US$3.11b due beyond that. On the other hand, it had cash of US$544.0m and US$1.10b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.13b.

This is a mountain of leverage relative to its market capitalization of US$3.60b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

With a debt to EBITDA ratio of 2.1, Resideo Technologies uses debt artfully but responsibly. And the alluring interest cover (EBIT of 8.3 times interest expense) certainly does not do anything to dispel this impression. Sadly, Resideo Technologies's EBIT actually dropped 5.7% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Resideo Technologies can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. Looking at the most recent three years, Resideo Technologies recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

At the end of the day, we're far from enamoured with Resideo Technologies's ability to handle its total liabilities or to grow its EBIT. But the silver lining is its relatively strong interest cover. Once we consider all the factors above, together, it seems to us that Resideo Technologies's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 Resideo Technologies is showing 3 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.