Here's Why Ignite International Brands (CSE:BILZ) Can Manage Its Debt Responsibly

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 can see that Ignite International Brands, Ltd. (CSE:BILZ) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Ignite International Brands

What Is Ignite International Brands's Debt?

As you can see below, at the end of March 2022, Ignite International Brands had CA$23.8m of debt, up from CA$14.0m a year ago. Click the image for more detail. However, it does have CA$18.8m in cash offsetting this, leading to net debt of about CA$5.05m.

How Strong Is Ignite International Brands' Balance Sheet?

According to the last reported balance sheet, Ignite International Brands had liabilities of CA$26.0m due within 12 months, and liabilities of CA$5.34m due beyond 12 months. Offsetting these obligations, it had cash of CA$18.8m as well as receivables valued at CA$8.59m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$3.96m.

Of course, Ignite International Brands has a market capitalization of CA$58.3m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 0.54 times EBITDA, it is initially surprising to see that Ignite International Brands's EBIT has low interest coverage of 2.1 times. So one way or the other, it's clear the debt levels are not trivial. We also note that Ignite International Brands improved its EBIT from a last year's loss to a positive CA$9.2m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ignite International Brands will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the most recent year, Ignite International Brands recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Ignite International Brands's demonstrated ability handle its debt, based on its EBITDA, delights us like a fluffy puppy does a toddler. But we must concede we find its interest cover has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Ignite International Brands can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Ignite International Brands , and understanding them should be part of your investment process.

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.

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.