Here's Why International Distributions Services (LON:IDS) Has A Meaningful Debt Burden

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.' 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. As with many other companies International Distributions Services plc (LON:IDS) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for International Distributions Services

How Much Debt Does International Distributions Services Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 International Distributions Services had UK£933.0m of debt, an increase on UK£897.0m, over one year. However, it does have UK£804.0m in cash offsetting this, leading to net debt of about UK£129.0m.

How Strong Is International Distributions Services' Balance Sheet?

According to the last reported balance sheet, International Distributions Services had liabilities of UK£2.45b due within 12 months, and liabilities of UK£2.46b due beyond 12 months. Offsetting this, it had UK£804.0m in cash and UK£1.58b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£2.53b.

Given this deficit is actually higher than the company's market capitalization of UK£2.18b, we think shareholders really should watch International Distributions Services'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 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.

With net debt sitting at just 0.20 times EBITDA, International Distributions Services is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.8 times the interest expense over the last year. It is just as well that International Distributions Services's load is not too heavy, because its EBIT was down 62% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if International Distributions Services 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, International Distributions Services recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

While International Distributions Services's EBIT growth rate has us nervous. To wit both its conversion of EBIT to free cash flow and net debt to EBITDA were encouraging signs. When we consider all the factors discussed, it seems to us that International Distributions Services is taking some risks with its use of debt. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - International Distributions Services has 2 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.