Impact Developer & Contractor (BVB:IMP) Takes On Some Risk With Its Use Of Debt

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.' 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. Importantly, Impact Developer & Contractor S.A. (BVB:IMP) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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.

See our latest analysis for Impact Developer & Contractor

What Is Impact Developer & Contractor's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Impact Developer & Contractor had debt of RON387.8m, up from RON337.0m in one year. However, because it has a cash reserve of RON55.1m, its net debt is less, at about RON332.7m.

How Healthy Is Impact Developer & Contractor's Balance Sheet?

We can see from the most recent balance sheet that Impact Developer & Contractor had liabilities of RON195.4m falling due within a year, and liabilities of RON358.4m due beyond that. Offsetting this, it had RON55.1m in cash and RON25.6m in receivables that were due within 12 months. So it has liabilities totalling RON473.1m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of RON688.2m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

While Impact Developer & Contractor's debt to EBITDA ratio of 8.9 suggests a heavy debt load, its interest coverage of 7.4 implies it services that debt with ease. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. Notably, Impact Developer & Contractor's EBIT launched higher than Elon Musk, gaining a whopping 190% 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 Impact Developer & Contractor 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Impact Developer & Contractor saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Impact Developer & Contractor's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Impact Developer & Contractor 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. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Impact Developer & Contractor you should know about.

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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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.