Is Itafos (CVE:IFOS) Using Debt In A Risky Way?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Itafos (CVE:IFOS) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Itafos

What Is Itafos's Net Debt?

As you can see below, at the end of December 2020, Itafos had US$240.2m of debt, up from US$211.3m a year ago. Click the image for more detail. However, it also had US$9.54m in cash, and so its net debt is US$230.7m.

How Healthy Is Itafos' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Itafos had liabilities of US$57.0m due within 12 months and liabilities of US$337.9m due beyond that. On the other hand, it had cash of US$9.54m and US$26.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$359.1m.

The deficiency here weighs heavily on the US$103.4m 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. After all, Itafos would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Itafos made a loss at the EBIT level, and saw its revenue drop to US$260m, which is a fall of 23%. That makes us nervous, to say the least.

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). Its EBIT loss was a whopping US$36m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through US$17m in the last year. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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. Case in point: We've spotted 2 warning signs for Itafos you should be aware of, and 1 of them is a bit concerning.

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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