These 4 Measures Indicate That Imperial Equities (CVE:IEI) Is Using Debt Extensively

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Imperial Equities Inc. (CVE:IEI) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. 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 Imperial Equities

How Much Debt Does Imperial Equities Carry?

The chart below, which you can click on for greater detail, shows that Imperial Equities had CA$131.1m in debt in December 2022; about the same as the year before. Net debt is about the same, since the it doesn't have much cash.

How Strong Is Imperial Equities' Balance Sheet?

According to the last reported balance sheet, Imperial Equities had liabilities of CA$58.5m due within 12 months, and liabilities of CA$93.2m due beyond 12 months. Offsetting these obligations, it had cash of CA$210.3k as well as receivables valued at CA$373.4k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$151.1m.

This deficit casts a shadow over the CA$41.1m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Imperial Equities would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 2.5 times and a disturbingly high net debt to EBITDA ratio of 11.4 hit our confidence in Imperial Equities like a one-two punch to the gut. The debt burden here is substantial. Notably, Imperial Equities's EBIT was pretty flat over the last year, which isn't ideal given the debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is Imperial Equities's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Imperial Equities recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

To be frank both Imperial Equities's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Imperial Equities has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the 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. To that end, you should learn about the 4 warning signs we've spotted with Imperial Equities (including 2 which can't be ignored) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.