Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘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. As with many other companies Rollins, Inc. (NYSE:ROL) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. 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. 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.
How Much Debt Does Rollins Carry?
You can click the graphic below for the historical numbers, but it shows that Rollins had US$88.1m of debt in June 2021, down from US$255.8m, one year before. But on the other hand it also has US$128.5m in cash, leading to a US$40.4m net cash position.
How Strong Is Rollins’ Balance Sheet?
According to the last reported balance sheet, Rollins had liabilities of US$518.7m due within 12 months, and liabilities of US$352.3m due beyond 12 months. Offsetting this, it had US$128.5m in cash and US$168.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$574.2m.
Of course, Rollins has a titanic market capitalization of US$19.4b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 28% in twelve months, making it easier to pay down debt. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Rollins’s ability to maintain a healthy balance sheet going forward.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Rollins 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. 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 puts it in a very strong position to pay down debt.
Summing up
We could understand if investors are concerned about Rollins’s liabilities, but we can be reassured by the fact it has has net cash of US$40.4m. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in US$396m. So is Rollins’s debt a risk? It doesn’t seem so to us.
