Is RTL Group (ETR:RRTL) a risky investment?

Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a 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. Above all, RTL Group SA (ETR:RRTL) is in debt. But the more important question is: what risk does this debt create?

Why is debt risky?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we look at debt levels, we first consider cash and debt levels, together.

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What is RTL Group’s debt?

The graph below, which you can click on for more details, shows that RTL Group had a debt of 698.0 million euros in June 2022; about the same as the previous year. However, he also had €507.0 million in cash, so his net debt is €191.0 million.

XTRA: RRTL Debt to Equity History September 13, 2022

How strong is RTL Group’s balance sheet?

Zooming in on the latest balance sheet data, we can see that RTL Group had liabilities of €3.49 billion maturing within 12 months and liabilities of €1.23 billion maturing beyond. In compensation for these obligations, it had cash of €507.0 million as well as receivables worth €2.08 billion at less than 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €2.13 billion.

While that might sound like a lot, it’s not too bad since RTL Group has a market capitalization of €5.81 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). 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 ).

RTL Group’s net debt represents only 0.16 times its EBITDA. And its EBIT covers its interest charges 53.0 times more. So we’re pretty relaxed about his super-conservative use of debt. The good news is that RTL Group increased its EBIT by 6.6% year-over-year, which should ease any worries about debt repayment. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine RTL Group’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, RTL Group has produced strong free cash flow equivalent to 71% of its EBIT, which is what we expected. This cold hard cash allows him to reduce his debt whenever he wants.

Our point of view

RTL Group’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And this is only the beginning of good news since its net debt to EBITDA is also very pleasing. Given all this data, it seems to us that RTL Group is taking a pretty sensible approach to debt. While this carries some risk, it can also improve shareholder returns. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. For example – RTL Group has 2 warning signs we think you should know.

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

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.

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