Health Check: How Prudently Does Itafos (CVE:IFOS) Use 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.' 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. We can see that Itafos Inc. (CVE:IFOS) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Itafos

How Much Debt Does Itafos Carry?

The image below, which you can click on for greater detail, shows that at March 2021 Itafos had debt of US$243.2m, up from US$216.0m in one year. However, because it has a cash reserve of US$17.7m, its net debt is less, at about US$225.6m.

A Look At Itafos' Liabilities

The latest balance sheet data shows that Itafos had liabilities of US$56.9m due within a year, and liabilities of US$340.2m falling due after that. Offsetting these obligations, it had cash of US$17.7m as well as receivables valued at US$33.0m due within 12 months. So it has liabilities totalling US$346.4m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the US$207.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Itafos would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Itafos'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.

Over 12 months, Itafos made a loss at the EBIT level, and saw its revenue drop to US$275m, which is a fall of 20%. We would much prefer see growth.

Caveat Emptor

Not only did Itafos's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost US$10m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of US$43m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Itafos , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.
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