Rakon (NZSE:RAK) Has A Rock Solid Balance Sheet

·4 min read

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 Rakon Limited (NZSE:RAK) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Rakon

How Much Debt Does Rakon Carry?

As you can see below, at the end of March 2022, Rakon had NZ$16.0m of debt, up from NZ$10.0m a year ago. Click the image for more detail. But it also has NZ$39.4m in cash to offset that, meaning it has NZ$23.4m net cash.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Rakon's Liabilities

The latest balance sheet data shows that Rakon had liabilities of NZ$43.3m due within a year, and liabilities of NZ$21.4m falling due after that. Offsetting these obligations, it had cash of NZ$39.4m as well as receivables valued at NZ$43.2m due within 12 months. So it can boast NZ$18.0m more liquid assets than total liabilities.

This surplus suggests that Rakon has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Rakon has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Rakon grew its EBIT by 316% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Rakon's ability to maintain a healthy balance sheet going forward. 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. Rakon 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 most recent three years, Rakon recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Rakon has net cash of NZ$23.4m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 316% over the last year. So is Rakon's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for Rakon you should be aware of.

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.

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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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