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.’ 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 Interpump Group S.p.A. (BIT:IP) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Interpump Group’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Interpump Group had €486.4m of debt, an increase on €432.7m, over one year. However, because it has a cash reserve of €104.8m, its net debt is less, at about €381.6m.
A Look At Interpump Group’s Liabilities
According to the last reported balance sheet, Interpump Group had liabilities of €489.5m due within 12 months, and liabilities of €400.5m due beyond 12 months. Offsetting this, it had €104.8m in cash and €330.3m in receivables that were due within 12 months. So its liabilities total €454.9m more than the combination of its cash and short-term receivables.
Given Interpump Group has a market capitalization of €2.73b, it’s hard to believe these liabilities pose much threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Interpump Group has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 68.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Interpump Group grew its EBIT at 17% 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 ultimately the future profitability of the business will decide if Interpump Group 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 business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Interpump Group’s free cash flow amounted to 43% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
The good news is that Interpump Group’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Looking at all the aforementioned factors together, it strikes us that Interpump Group can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it’s worth keeping an eye on this one. We’d be motivated to research the stock further if we found out that Interpump Group insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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