Is Impellam Group (LON:IPEL) Using Too Much Debt?

Warren Buffett famously said, '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, Impellam Group PLC (LON:IPEL) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Impellam Group

What Is Impellam Group's Net Debt?

As you can see below, Impellam Group had UK£150.2m of debt at July 2020, down from UK£164.2m a year prior. However, because it has a cash reserve of UK£135.0m, its net debt is less, at about UK£15.2m.

How Healthy Is Impellam Group's Balance Sheet?

We can see from the most recent balance sheet that Impellam Group had liabilities of UK£603.0m falling due within a year, and liabilities of UK£138.8m due beyond that. Offsetting this, it had UK£135.0m in cash and UK£540.9m in receivables that were due within 12 months. So its liabilities total UK£65.9m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of UK£107.0m, so it does suggest shareholders should keep an eye on Impellam Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Impellam Group has a very low debt to EBITDA ratio of 0.96 so it is strange to see weak interest coverage, with last year's EBIT being only 0.76 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Importantly, Impellam Group's EBIT fell a jaw-dropping 70% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Impellam Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Impellam Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Impellam Group's EBIT growth rate and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think Impellam Group's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. To that end, you should be aware of the 2 warning signs we've spotted with Impellam Group .

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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