Here’s Why Resolute Forest Products (NYSE:RFP) Is Weighed Down By Its Debt Load

David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ 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. Importantly, Resolute Forest Products Inc. (NYSE:RFP) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Resolute Forest Products’s Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Resolute Forest Products had US$552.0m of debt, an increase on US$417.0m, over one year. However, because it has a cash reserve of US$20.0m, its net debt is less, at about US$532.0m.

debt-equity-history-analysis
NYSE:RFP Debt to Equity History January 12th 2021

A Look At Resolute Forest Products’ Liabilities

Zooming in on the latest balance sheet data, we can see that Resolute Forest Products had liabilities of US$349.0m due within 12 months and liabilities of US$2.03b due beyond that. Offsetting this, it had US$20.0m in cash and US$319.0m in receivables that were due within 12 months. So its liabilities total US$2.04b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$593.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Resolute Forest Products would likely require a major re-capitalisation if it had to pay its creditors today.

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.

While Resolute Forest Products has a quite reasonable net debt to EBITDA multiple of 2.5, its interest cover seems weak, at 1.4. In large part that’s it has so much depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) Either way there’s no doubt the stock is using meaningful leverage. Importantly, Resolute Forest Products’s EBIT fell a jaw-dropping 67% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Resolute Forest Products’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. So it’s worth checking how much of that EBIT is backed by free cash flow. During the last three years, Resolute Forest Products produced sturdy free cash flow equating to 74% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, Resolute Forest Products’s EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it’s pretty decent at converting EBIT to free cash flow; that’s encouraging. Overall, it seems to us that Resolute Forest Products’s balance sheet is really quite a risk to the business. For this reason we’re pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Consider risks, for instance. Every company has them, and we’ve spotted 2 warning signs for Resolute Forest Products you should know about.

When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Source: https://simplywall.st/stocks/us/materials/nyse-rfp/resolute-forest-products/news/heres-why-resolute-forest-products-nyserfp-is-weighed-down-b