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Warren Buffett famously said, ‘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. We note that The InterGroup Corporation (NASDAQ:INTG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 InterGroup’s Net Debt?
The chart below, which you can click on for greater detail, shows that InterGroup had US$182.1m in debt in March 2019; about the same as the year before. However, because it has a cash reserve of US$22.3m, its net debt is less, at about US$159.8m.
How Healthy Is InterGroup’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that InterGroup had liabilities of US$16.6m due within 12 months and liabilities of US$179.8m due beyond that. Offsetting this, it had US$22.3m in cash and US$3.54m in receivables that were due within 12 months. So it has liabilities totalling US$170.5m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the US$71.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt After all, InterGroup would likely require a major re-capitalisation if it had to pay its creditors today. Either way, since InterGroup does have more debt than cash, it’s worth keeping an eye on its balance sheet.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
InterGroup shareholders face the double whammy of a high net debt to EBITDA ratio (7.89), and fairly weak interest coverage, since EBIT is just 1.58 times the interest expense. This means we’d consider it to have a heavy debt load. Looking on the bright side, InterGroup boosted its EBIT by a silky 36% in the last year. Like a mother’s loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. There’s no doubt that we learn most about debt from the balance sheet. But it is InterGroup’s earnings that will influence how the balance sheet holds up in the future. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, InterGroup produced sturdy free cash flow equating to 79% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
To be frank both InterGroup’s net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it’s pretty decent at growing its EBIT; that’s encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making InterGroup stock a bit risky. Some people like that sort of risk, but we’re mindful of the potential pitfalls, so we’d probably prefer it carry less debt. Over time, share prices tend to follow earnings per share, so if you’re interested in InterGroup, you may well want to click here to check an interactive graph of its earnings per share history.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.