Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Imdex Limited (ASX:IMD) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. 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. 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 Imdex's Net Debt?
The chart below, which you can click on for greater detail, shows that Imdex had AU$6.12m in debt in June 2020; about the same as the year before. However, it does have AU$38.3m in cash offsetting this, leading to net cash of AU$32.1m.
A Look At Imdex's Liabilities
According to the last reported balance sheet, Imdex had liabilities of AU$40.4m due within 12 months, and liabilities of AU$56.1m due beyond 12 months. On the other hand, it had cash of AU$38.3m and AU$46.7m worth of receivables due within a year. So its liabilities total AU$11.6m more than the combination of its cash and short-term receivables.
Of course, Imdex has a market capitalization of AU$549.1m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Imdex also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Imdex's EBIT dived 17%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Imdex can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Imdex may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Imdex's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Imdex has AU$32.1m in net cash. So we don't have any problem with Imdex's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Imdex is showing 2 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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