Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Rollins, Inc. (NYSE:ROL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Rollins’s Debt?
You can click the graphic below for the historical numbers, but it shows that Rollins had US$115.2m of debt in March 2021, down from US$320.8m, one year before. However, its balance sheet shows it holds US$117.3m in cash, so it actually has US$2.12m net cash.
How Healthy Is Rollins’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Rollins had liabilities of US$507.8m due within 12 months and liabilities of US$380.2m due beyond that. On the other hand, it had cash of US$117.3m and US$144.8m worth of receivables due within a year. So its liabilities total US$625.8m more than the combination of its cash and short-term receivables.
Since publicly traded Rollins shares are worth a very impressive total of US$17.2b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Rollins also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Another good sign is that Rollins has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Rollins can strengthen its balance sheet over time.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Rollins has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Rollins generated free cash flow amounting to a very robust 99% of its EBIT, more than we’d expect. That positions it well to pay down debt if desirable to do so.
Summing up
While it is always sensible to look at a company’s total liabilities, it is very reassuring that Rollins has US$2.12m in net cash. And it impressed us with free cash flow of US$439m, being 99% of its EBIT. So we don’t think Rollins’s use of debt is risky.
