Tetra Tech (NASDAQ:TTEK) Seems To Use Debt Rather Sparingly

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.' 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 Tetra Tech, Inc. (NASDAQ:TTEK) makes use of debt. But the real question is whether this debt is making the company risky.

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When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Tetra Tech's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Tetra Tech had US$888.5m of debt in December 2024, down from US$945.3m, one year before. However, it also had US$248.1m in cash, and so its net debt is US$640.3m.

How Healthy Is Tetra Tech's Balance Sheet?

We can see from the most recent balance sheet that Tetra Tech had liabilities of US$1.27b falling due within a year, and liabilities of US$1.22b due beyond that. Offsetting these obligations, it had cash of US$248.1m as well as receivables valued at US$1.24b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$999.1m.

Given Tetra Tech has a market capitalization of US$7.92b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

View our latest analysis for Tetra Tech

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).

Tetra Tech has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 15.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Tetra Tech has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Tetra Tech can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Tetra Tech recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Tetra Tech's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Tetra Tech seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Tetra Tech , and understanding them should be part of your investment process.

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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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.