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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that IHS Markit Ltd. (NYSE:INFO) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is IHS Markit's Net Debt?
You can click the graphic below for the historical numbers, but it shows that IHS Markit had US$4.90b of debt in November 2020, down from US$5.12b, one year before. However, because it has a cash reserve of US$125.6m, its net debt is less, at about US$4.78b.
How Strong Is IHS Markit's Balance Sheet?
According to the last reported balance sheet, IHS Markit had liabilities of US$1.98b due within 12 months, and liabilities of US$5.61b due beyond 12 months. Offsetting these obligations, it had cash of US$125.6m as well as receivables valued at US$891.7m due within 12 months. So it has liabilities totalling US$6.57b more than its cash and near-term receivables, combined.
Since publicly traded IHS Markit shares are worth a very impressive total of US$37.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
IHS Markit has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 4.0 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. More concerning, IHS Markit saw its EBIT drop by 2.8% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine IHS Markit's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, IHS Markit actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
On our analysis IHS Markit's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit handle its debt, based on its EBITDA,. When we consider all the elements mentioned above, it seems to us that IHS Markit is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Be aware that IHS Markit is showing 3 warning signs in our investment analysis , 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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