We Think IWG (LON:IWG) Is Taking Some Risk With Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that IWG plc (LON:IWG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for IWG

What Is IWG's Net Debt?

As you can see below, IWG had UK£782.0m of debt at June 2023, down from UK£947.2m a year prior. However, it also had UK£124.0m in cash, and so its net debt is UK£658.0m.

How Healthy Is IWG's Balance Sheet?

We can see from the most recent balance sheet that IWG had liabilities of UK£2.95b falling due within a year, and liabilities of UK£5.59b due beyond that. Offsetting this, it had UK£124.0m in cash and UK£1.18b in receivables that were due within 12 months. So its liabilities total UK£7.24b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the UK£1.38b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, IWG would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 1.2 times EBITDA, it is initially surprising to see that IWG's EBIT has low interest coverage of 1.0 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, IWG's EBIT launched higher than Elon Musk, gaining a whopping 547% on last year. 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 IWG'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, IWG actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

While IWG's level of total liabilities has us nervous. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that IWG is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

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.