U.S. Markets close in 1 hr 18 mins

IDP Education (ASX:IEL) Seems To Use Debt Rather Sparingly

Simply Wall St

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. Importantly, IDP Education Limited (ASX:IEL) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for IDP Education

What Is IDP Education's Net Debt?

As you can see below, at the end of December 2018, IDP Education had AU$64.4m of debt, up from AU$47.1m a year ago. Click the image for more detail. On the flip side, it has AU$54.8m in cash leading to net debt of about AU$9.65m.

ASX:IEL Historical Debt, August 19th 2019

A Look At IDP Education's Liabilities

We can see from the most recent balance sheet that IDP Education had liabilities of AU$133.9m falling due within a year, and liabilities of AU$71.1m due beyond that. Offsetting these obligations, it had cash of AU$54.8m as well as receivables valued at AU$109.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$41.2m.

Having regard to IDP Education's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the AU$4.78b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, IDP Education has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

IDP Education has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.095 and EBIT of 113 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. Also positive, IDP Education grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if IDP Education can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, IDP Education produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

IDP Education's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think IDP Education's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Another factor that would give us confidence in IDP Education would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.