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. As with many other companies Identiv, Inc. (NASDAQ:INVE) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Identiv's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Identiv had US$13.2m of debt in June 2019, down from US$15.6m, one year before. On the flip side, it has US$11.1m in cash leading to net debt of about US$2.11m.
How Healthy Is Identiv's Balance Sheet?
According to the last reported balance sheet, Identiv had liabilities of US$34.0m due within 12 months, and liabilities of US$6.26m due beyond 12 months. Offsetting these obligations, it had cash of US$11.1m as well as receivables valued at US$17.6m due within 12 months. So it has liabilities totalling US$11.6m more than its cash and near-term receivables, combined.
Since publicly traded Identiv shares are worth a total of US$84.6m, 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.
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.
Identiv has a very low debt to EBITDA ratio of 0.36 so it is strange to see weak interest coverage, with last year's EBIT being only 2.4 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that Identiv improved its EBIT from a last year's loss to a positive US$2.6m. 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 Identiv's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Identiv burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Identiv's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability handle its debt, based on its EBITDA, isn't too shabby at all. Taking the abovementioned factors together we do think Identiv's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
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.
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