IDP Education (ASX:IEL) Could Easily Take On More Debt

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.' 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. Importantly, IDP Education Limited (ASX:IEL) does carry debt. 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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for IDP Education

How Much Debt Does IDP Education Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 IDP Education had AU$156.5m of debt, an increase on AU$56.7m, over one year. However, it does have AU$196.6m in cash offsetting this, leading to net cash of AU$40.2m.

A Look At IDP Education's Liabilities

We can see from the most recent balance sheet that IDP Education had liabilities of AU$229.6m falling due within a year, and liabilities of AU$289.8m due beyond that. Offsetting these obligations, it had cash of AU$196.6m as well as receivables valued at AU$149.8m due within 12 months. So it has liabilities totalling AU$173.0m more than its cash and near-term receivables, combined.

Of course, IDP Education has a market capitalization of AU$7.32b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, IDP Education boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that IDP Education grew its EBIT by 180% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if IDP Education 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. IDP Education 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. Over the last three years, IDP Education recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about IDP Education's liabilities, but we can be reassured by the fact it has has net cash of AU$40.2m. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in AU$111m. So is IDP Education's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of IDP Education's earnings per share history 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.