Imerys (EPA:NK) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Imerys S.A. (EPA:NK) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Imerys

What Is Imerys's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Imerys had debt of €2.25b, up from €1.74b in one year. However, it also had €605.9m in cash, and so its net debt is €1.65b.

How Healthy Is Imerys' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Imerys had liabilities of €1.55b due within 12 months and liabilities of €2.41b due beyond that. Offsetting this, it had €605.9m in cash and €594.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.76b.

Given this deficit is actually higher than the company's market capitalization of €2.53b, we think shareholders really should watch Imerys's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Imerys has net debt to EBITDA of 3.5 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 9.8 times its interest expense, and its net debt to EBITDA, was quite high, at 3.5. Shareholders should be aware that Imerys's EBIT was down 29% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Imerys'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Imerys's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Imerys's EBIT growth rate was disappointing. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider Imerys to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Imerys , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.