Rent-A-Center (NASDAQ:RCII) has a somewhat strained balance sheet

David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Rent-A-Center, Inc. (NASDAQ:RCII) uses debt. But does this debt worry shareholders?

When is debt a problem?

Debt helps a business until the business struggles to pay it back, 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 it has to raise new equity at a low price, thereby permanently diluting shareholders. 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.

Check out our latest analysis for Rent-A-Center

How much debt does Rent-A-Center bear?

As you can see below, at the end of June 2022, Rent-A-Center had $1.37 billion in debt, up from $1.28 billion a year ago. Click on the image for more details. On the other hand, he has $112.2 million in cash, resulting in a net debt of around $1.26 billion.

NasdaqGS:RCII Debt to Equity History August 17, 2022

How healthy is Rent-A-Center’s balance sheet?

The latest balance sheet data shows that Rent-A-Center had liabilities of US$492.1 million due within one year, and liabilities of US$1.72 billion falling due thereafter. In compensation for these obligations, it had cash of US$112.2 million as well as receivables valued at US$122.6 million and maturing within 12 months. It therefore has liabilities totaling $1.97 billion more than its cash and short-term receivables, combined.

Given that this deficit is actually greater than the company’s market cap of $1.85 billion, we think shareholders really should be watching Rent-A-Center’s debt levels, like a parent watching her child riding a bike for the first time. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.

We measure a company’s leverage against its earning power 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 charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Rent-A-Center has a debt to EBITDA ratio of 3.4 and its EBIT covered its interest expense 2.7 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. Worse still, Rent-A-Center has seen its EBIT drop 44% in the last 12 months. If earnings continue to follow this trajectory, paying off this debt will be more difficult than convincing us to run a marathon in the rain. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Rent-A-Center can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Fortunately for all shareholders, Rent-A-Center has actually produced more free cash flow than EBIT for the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our point of view

We would go so far as to say that Rent-A-Center’s EBIT growth rate is disappointing. But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. Overall, we think it’s fair to say that Rent-A-Center has enough debt that there is real risk around the balance sheet. If all goes well, it can pay off, but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 4 warning signs for Rent-A-Center you should be aware, and 1 of them is a bit unpleasant.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

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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