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 iEnergizer Limited (LON:IBPO) makes use of debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does iEnergizer Carry?
As you can see below, iEnergizer had US$33.2m of debt at September 2020, down from US$48.8m a year prior. However, its balance sheet shows it holds US$52.9m in cash, so it actually has US$19.7m net cash.
A Look At iEnergizer's Liabilities
Zooming in on the latest balance sheet data, we can see that iEnergizer had liabilities of US$37.8m due within 12 months and liabilities of US$43.9m due beyond that. On the other hand, it had cash of US$52.9m and US$30.6m worth of receivables due within a year. So it can boast US$1.82m more liquid assets than total liabilities.
Having regard to iEnergizer's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$713.2m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that iEnergizer has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that iEnergizer grew its EBIT at 13% over the last year, further increasing its ability to manage debt. 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 iEnergizer'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While iEnergizer has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, iEnergizer generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case iEnergizer has US$19.7m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 95% of that EBIT to free cash flow, bringing in US$54m. So we don't think iEnergizer's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for iEnergizer that you should be aware of.
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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