Health Check: How Prudently Does RealReal (NASDAQ:REAL) Use Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that The RealReal, Inc. (NASDAQ:REAL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for RealReal

How Much Debt Does RealReal Carry?

As you can see below, at the end of December 2020, RealReal had US$149.2m of debt, up from none a year ago. Click the image for more detail. But it also has US$354.9m in cash to offset that, meaning it has US$205.7m net cash.

A Look At RealReal's Liabilities

Zooming in on the latest balance sheet data, we can see that RealReal had liabilities of US$148.3m due within 12 months and liabilities of US$265.6m due beyond that. Offsetting these obligations, it had cash of US$354.9m as well as receivables valued at US$7.21m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$51.7m.

Since publicly traded RealReal shares are worth a total of US$2.14b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, RealReal boasts net cash, so it's fair to say it does not have a heavy debt load! 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 RealReal'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.

Over 12 months, RealReal made a loss at the EBIT level, and saw its revenue drop to US$300m, which is a fall of 5.2%. That's not what we would hope to see.

So How Risky Is RealReal?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year RealReal had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$161m and booked a US$176m accounting loss. However, it has net cash of US$205.7m, so it has a bit of time before it will need more capital. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that RealReal is showing 3 warning signs in our investment analysis , 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.

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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