Here’s Why iomart Group (LON:IOM) Can Manage Its Debt Responsibly

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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, iomart Group plc (LON:IOM) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for iomart Group

What Is iomart Group’s Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2019 iomart Group had UK£48.5m of debt, an increase on UK£36.1m, over one year. However, because it has a cash reserve of UK£10.1m, its net debt is less, at about UK£38.5m.

AIM:IOM Historical Debt, October 23rd 2019
AIM:IOM Historical Debt, October 23rd 2019

How Strong Is iomart Group’s Balance Sheet?

According to the last reported balance sheet, iomart Group had liabilities of UK£35.6m due within 12 months, and liabilities of UK£51.0m due beyond 12 months. Offsetting this, it had UK£10.1m in cash and UK£9.37m in receivables that were due within 12 months. So it has liabilities totalling UK£67.2m more than its cash and near-term receivables, combined.

Of course, iomart Group has a market capitalization of UK£408.9m, so these liabilities are probably manageable. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

iomart Group’s net debt is only 0.99 times its EBITDA. And its EBIT covers its interest expense a whopping 17.1 times over. So we’re pretty relaxed about its super-conservative use of debt. Fortunately, iomart Group grew its EBIT by 8.5% in the last year, making that debt load look even more manageable. 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 iomart Group 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 company can only pay off debt with cold hard cash, not accounting profits. So it’s worth checking how much of that EBIT is backed by free cash flow. During the last three years, iomart Group generated free cash flow amounting to a very robust 94% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that iomart Group’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Looking at the bigger picture, we think iomart Group’s use of debt seems quite reasonable and we’re not concerned about it. After all, sensible leverage can boost returns on equity. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you’ve also come to that realization, you’re in luck, because today you can view this interactive graph of iomart Group’s earnings per share history for free.

When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.