Is Imerys (EPA:NK) A Risky Investment?

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. Importantly, Imerys S.A. (EPA:NK) does carry debt. But is this debt a concern to shareholders?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Imerys

What Is Imerys's Net Debt?

As you can see below, Imerys had €2.24b of debt at June 2021, down from €2.77b a year prior. On the flip side, it has €695.4m in cash leading to net debt of about €1.54b.

A Look At Imerys' Liabilities

We can see from the most recent balance sheet that Imerys had liabilities of €1.45b falling due within a year, and liabilities of €2.67b due beyond that. On the other hand, it had cash of €695.4m and €890.4m worth of receivables due within a year. So it has liabilities totalling €2.54b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of €3.00b, so it does suggest shareholders should keep an eye on Imerys' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Imerys's net debt to EBITDA ratio of about 2.2 suggests only moderate use of debt. And its strong interest cover of 14.5 times, makes us even more comfortable. It is well worth noting that Imerys's EBIT shot up like bamboo after rain, gaining 62% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Imerys can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Imerys produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Imerys's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its level of total liabilities. Looking at all the aforementioned factors together, it strikes us that Imerys can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. For example - Imerys has 3 warning signs we think you should be aware of.

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.