Is IDP Education (ASX:IEL) Using Too Much Debt?

Warren Buffett famously said, '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. We note that IDP Education Limited (ASX:IEL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

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 December 2022 IDP Education had AU$218.9m of debt, an increase on AU$156.4m, over one year. However, it also had AU$134.8m in cash, and so its net debt is AU$84.1m.

A Look At IDP Education's Liabilities

We can see from the most recent balance sheet that IDP Education had liabilities of AU$259.5m falling due within a year, and liabilities of AU$370.1m due beyond that. Offsetting this, it had AU$134.8m in cash and AU$258.9m in receivables that were due within 12 months. So its liabilities total AU$235.9m more than the combination of its cash and short-term receivables.

Of course, IDP Education has a market capitalization of AU$7.86b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Carrying virtually no net debt, IDP Education has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

IDP Education has a low net debt to EBITDA ratio of only 0.40. And its EBIT covers its interest expense a whopping 25.6 times over. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that IDP Education grew its EBIT by 119% over twelve months. That boost will make it even easier to pay down debt going forward. 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 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, IDP Education produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that IDP Education'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! Overall, we don't think IDP Education is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. Over time, share prices tend to follow earnings per share, so if you're interested in IDP Education, you may well want to click here to check an interactive graph of its earnings per share history.

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.