Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Internity S.A. (WSE:INT) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Internity Carry?
You can click the graphic below for the historical numbers, but it shows that Internity had zł7.85m of debt in March 2021, down from zł9.64m, one year before. However, it does have zł9.37m in cash offsetting this, leading to net cash of zł1.52m.
A Look At Internity's Liabilities
Zooming in on the latest balance sheet data, we can see that Internity had liabilities of zł33.9m due within 12 months and liabilities of zł2.04m due beyond that. Offsetting these obligations, it had cash of zł9.37m as well as receivables valued at zł5.04m due within 12 months. So its liabilities total zł21.5m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of zł35.3m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Internity also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that Internity has boosted its EBIT by 88%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Internity 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Internity has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Internity recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While Internity does have more liabilities than liquid assets, it also has net cash of zł1.52m. The cherry on top was that in converted 97% of that EBIT to free cash flow, bringing in zł5.4m. So we don't think Internity's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Internity you should be aware of, and 1 of them is concerning.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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