These 4 Measures Indicate That Impact Developer & Contractor (BVB:IMP) Is Using Debt Extensively

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.' 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. We can see that Impact Developer & Contractor S.A. (BVB:IMP) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Impact Developer & Contractor

What Is Impact Developer & Contractor's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Impact Developer & Contractor had debt of RON255.8m, up from RON197.6m in one year. However, it also had RON59.0m in cash, and so its net debt is RON196.8m.

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

We can see from the most recent balance sheet that Impact Developer & Contractor had liabilities of RON122.5m falling due within a year, and liabilities of RON224.6m due beyond that. On the other hand, it had cash of RON59.0m and RON27.6m worth of receivables due within a year. So it has liabilities totalling RON260.4m more than its cash and near-term receivables, combined.

Impact Developer & Contractor has a market capitalization of RON616.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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 5.6, it's fair to say Impact Developer & Contractor does have a significant amount of debt. However, its interest coverage of 6.1 is reasonably strong, which is a good sign. Importantly, Impact Developer & Contractor's EBIT fell a jaw-dropping 25% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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 that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Impact Developer & Contractor's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to cover its interest expense with its EBIT isn't such a worry. Overall, it seems to us that Impact Developer & Contractor's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. 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.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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