We Think Interfor (TSE:IFP) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Interfor Corporation (TSE:IFP) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Interfor

What Is Interfor's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Interfor had debt of CA$382.0m, up from CA$259.8m in one year. However, its balance sheet shows it holds CA$457.4m in cash, so it actually has CA$75.4m net cash.

How Strong Is Interfor's Balance Sheet?

The latest balance sheet data shows that Interfor had liabilities of CA$189.7m due within a year, and liabilities of CA$573.1m falling due after that. On the other hand, it had cash of CA$457.4m and CA$117.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$187.9m.

Given Interfor has a market capitalization of CA$2.15b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Interfor boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Interfor turned things around in the last 12 months, delivering and EBIT of CA$430m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Interfor's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Interfor has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Interfor recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Interfor has CA$75.4m in net cash. And it impressed us with free cash flow of CA$360m, being 84% of its EBIT. So is Interfor's debt a risk? It doesn't seem so to us. 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. Be aware that Interfor is showing 3 warning signs in our investment analysis , and 1 of those 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.

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