These 4 Measures Indicate That IDP Education (ASX:IEL) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. 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

What Is IDP Education's Debt?

As you can see below, IDP Education had AU$56.7m of debt at June 2021, down from AU$59.8m a year prior. But on the other hand it also has AU$306.9m in cash, leading to a AU$250.2m net cash position.

How Strong Is IDP Education's Balance Sheet?

We can see from the most recent balance sheet that IDP Education had liabilities of AU$170.8m falling due within a year, and liabilities of AU$136.6m due beyond that. Offsetting these obligations, it had cash of AU$306.9m as well as receivables valued at AU$109.5m due within 12 months. So it actually has AU$109.0m more liquid assets than total liabilities.

This state of affairs indicates that IDP Education's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the AU$11.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that IDP Education has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that IDP Education's load is not too heavy, because its EBIT was down 45% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine IDP Education'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. 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 generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that IDP Education has net cash of AU$250.2m, as well as more liquid assets than liabilities. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in AU$97m. So we don't have any problem with IDP Education's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for IDP Education 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.

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.

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