Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, IG Design Group plc (LON:IGR) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does IG Design Group Carry?
The image below, which you can click on for greater detail, shows that IG Design Group had debt of UK£24.8m at the end of March 2020, a reduction from UK£68.2m over a year. But it also has UK£67.1m in cash to offset that, meaning it has UK£42.3m net cash.
A Look At IG Design Group’s Liabilities
According to the last reported balance sheet, IG Design Group had liabilities of UK£182.5m due within 12 months, and liabilities of UK£74.2m due beyond 12 months. Offsetting these obligations, it had cash of UK£67.1m as well as receivables valued at UK£92.9m due within 12 months. So it has liabilities totalling UK£96.7m more than its cash and near-term receivables, combined.
This deficit isn’t so bad because IG Design Group is worth UK£431.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, IG Design Group boasts net cash, so it’s fair to say it does not have a heavy debt load!
On the other hand, IG Design Group saw its EBIT drop by 3.5% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 IG Design Group’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, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. IG Design Group 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. During the last three years, IG Design Group produced sturdy free cash flow equating to 62% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
While IG Design Group does have more liabilities than liquid assets, it also has net cash of UK£42.3m. So we don’t have any problem with IG Design Group’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. Case in point: We’ve spotted 5 warning signs for IG Design Group 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.
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