Warren Buffett said: “Volatility is far from synonymous with risk”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. Mostly, Rattler Midstream LP (NASDAQ: RTLR) is in debt. But does this debt worry shareholders?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest review for Rattler Midstream
What is Rattler Midstream’s debt?
As you can see below, at the end of March 2021, Rattler Midstream had $ 545.4 million in debt, down from $ 451.0 million a year ago. Click on the image for more details. Net debt is about the same because it doesn’t have a lot of cash.
A look at the responsibilities of Rattler Midstream
We can see from the most recent balance sheet that Rattler Midstream had liabilities of US $ 40.6 million due within one year and liabilities of US $ 561.1 million beyond. In compensation for these obligations, it had cash of US $ 9.76 million as well as receivables valued at US $ 53.3 million at 12 months. Its liabilities therefore exceed the sum of its cash and (short-term) receivables by US $ 538.6 million.
While that might sound like a lot, it’s not that big of a deal since Rattler Midstream has a market cap of $ 1.57 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt over EBITDA) and the actual interest charges associated with that debt (with its interest coverage ratio).
Rattler Midstream has a net debt to EBITDA of 2.5, which suggests that he is using good leverage to increase returns. On the positive side, its EBIT was 7.5 times its interest expense and its net debt to EBITDA was quite high, at 2.5. It is important to note that Rattler Midstream’s EBIT has fallen 29% over the past twelve months. If this decline continues, then it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Rattler Midstream 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, a business can only repay its debts with hard cash, not with book profits. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Rattler Midstream has achieved free cash flow of 24% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.
Our point of view
We would go so far as to say that Rattler Midstream’s EBIT growth rate was disappointing. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. Looking at the balance sheet and taking all of these factors into account, we think debt makes Rattler Midstream stock a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 2 warning signs for Rattler Midstream you must be aware.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page. free list of growing companies that have net cash on the balance sheet.
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