Is Ideal Holdings (ATH:INTEK) A Risky Investment?

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.' 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, Ideal Holdings S.A. (ATH:INTEK) 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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Ideal Holdings

What Is Ideal Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Ideal Holdings had debt of €50.0m, up from €28.0m in one year. However, because it has a cash reserve of €22.8m, its net debt is less, at about €27.1m.

How Strong Is Ideal Holdings' Balance Sheet?

According to the last reported balance sheet, Ideal Holdings had liabilities of €78.7m due within 12 months, and liabilities of €34.3m due beyond 12 months. Offsetting these obligations, it had cash of €22.8m as well as receivables valued at €85.8m due within 12 months. So its liabilities total €4.36m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Ideal Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the €246.5m company is struggling for cash, we still think it's worth monitoring its balance sheet.

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.

While Ideal Holdings's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.3 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably, Ideal Holdings's EBIT launched higher than Elon Musk, gaining a whopping 193% on last year. 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 Ideal Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ideal Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Ideal Holdings is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. Considering this range of data points, we think Ideal Holdings is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Ideal Holdings (of which 2 can't be ignored!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.