Intertrust (AMS:INTER) Has A Somewhat Strained Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Intertrust N.V. (AMS:INTER) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Intertrust

How Much Debt Does Intertrust Carry?

The image below, which you can click on for greater detail, shows that Intertrust had debt of €928.7m at the end of September 2020, a reduction from €1.02b over a year. However, because it has a cash reserve of €116.8m, its net debt is less, at about €811.9m.

How Strong Is Intertrust's Balance Sheet?

The latest balance sheet data shows that Intertrust had liabilities of €227.7m due within a year, and liabilities of €1.08b falling due after that. Offsetting this, it had €116.8m in cash and €147.9m in receivables that were due within 12 months. So its liabilities total €1.04b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of €1.27b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

Intertrust's debt is 4.3 times its EBITDA, and its EBIT cover its interest expense 3.2 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Another concern for investors might be that Intertrust's EBIT fell 12% in the last year. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Intertrust'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Intertrust actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Intertrust's EBIT growth rate and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think Intertrust's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for Intertrust you should know about.

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.

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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. 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.
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