Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, IDP Education Limited (ASX:IEL) does carry debt. But the real question is whether this debt is making the company risky.
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does IDP Education Carry?
The image below, which you can click on for greater detail, shows that IDP Education had debt of AU$59.3m at the end of December 2020, a reduction from AU$62.7m over a year. But it also has AU$292.8m in cash to offset that, meaning it has AU$233.5m net cash.
How Healthy Is IDP Education's Balance Sheet?
The latest balance sheet data shows that IDP Education had liabilities of AU$205.6m due within a year, and liabilities of AU$82.0m falling due after that. Offsetting these obligations, it had cash of AU$292.8m as well as receivables valued at AU$121.7m due within 12 months. So it actually has AU$127.0m more liquid assets than total liabilities.
This short term liquidity is a sign that IDP Education could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, IDP Education boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact IDP Education's saving grace is its low debt levels, because its EBIT has tanked 54% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, IDP Education produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While we empathize with investors who find debt concerning, you should keep in mind that IDP Education has net cash of AU$233.5m, as well as more liquid assets than liabilities. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in AU$54m. So we are not troubled with IDP Education's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for IDP Education that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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