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. 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 Infotel SA (EPA:INF) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. 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 Infotel Carry?
The image below, which you can click on for greater detail, shows that at June 2019 Infotel had debt of €5.0k, up from none in one year. But it also has €62.5m in cash to offset that, meaning it has €62.5m net cash.
How Healthy Is Infotel’s Balance Sheet?
We can see from the most recent balance sheet that Infotel had liabilities of €75.6m falling due within a year, and liabilities of €15.0m due beyond that. On the other hand, it had cash of €62.5m and €70.9m worth of receivables due within a year. So it actually has €42.8m more liquid assets than total liabilities.
This excess liquidity suggests that Infotel is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Infotel boasts net cash, so it’s fair to say it does not have a heavy debt load!
On the other hand, Infotel 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Infotel 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. While Infotel 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. Over the most recent three years, Infotel recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Infotel has net cash of €62.5m, as well as more liquid assets than liabilities. The cherry on top was that in converted 74% of that EBIT to free cash flow, bringing in €17m. So we don’t think Infotel’s use of debt is risky. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Infotel’s dividend history, without delay!
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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