Here's Why Infrastrutture Wireless Italiane (BIT:INW) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Infrastrutture Wireless Italiane S.p.A. (BIT:INW) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Infrastrutture Wireless Italiane

What Is Infrastrutture Wireless Italiane's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Infrastrutture Wireless Italiane had debt of €2.81b, up from €180.6m in one year. However, it also had €117.5m in cash, and so its net debt is €2.69b.

How Strong Is Infrastrutture Wireless Italiane's Balance Sheet?

The latest balance sheet data shows that Infrastrutture Wireless Italiane had liabilities of €1.10b due within a year, and liabilities of €3.53b falling due after that. Offsetting these obligations, it had cash of €117.5m as well as receivables valued at €196.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €4.32b.

While this might seem like a lot, it is not so bad since Infrastrutture Wireless Italiane has a huge market capitalization of €8.46b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With a net debt to EBITDA ratio of 7.2, it's fair to say Infrastrutture Wireless Italiane does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 6.7 times, suggesting it can responsibly service its obligations. Importantly, Infrastrutture Wireless Italiane grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. 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 Infrastrutture Wireless Italiane's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Infrastrutture Wireless Italiane actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that Infrastrutture Wireless Italiane's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its net debt to EBITDA. All these things considered, it appears that Infrastrutture Wireless Italiane can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Infrastrutture Wireless Italiane has 4 warning signs (and 2 which can't be ignored) we think 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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