We Think Ituran Location and Control (NASDAQ:ITRN) Can Stay On Top Of Its 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Ituran Location and Control Ltd. (NASDAQ:ITRN) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Ituran Location and Control

What Is Ituran Location and Control's Net Debt?

As you can see below, Ituran Location and Control had US$55.0m of debt at September 2020, down from US$74.5m a year prior. However, its balance sheet shows it holds US$61.9m in cash, so it actually has US$6.97m net cash.

A Look At Ituran Location and Control's Liabilities

Zooming in on the latest balance sheet data, we can see that Ituran Location and Control had liabilities of US$107.4m due within 12 months and liabilities of US$75.6m due beyond that. On the other hand, it had cash of US$61.9m and US$40.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$81.0m.

Ituran Location and Control has a market capitalization of US$396.5m, 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. Despite its noteworthy liabilities, Ituran Location and Control boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Ituran Location and Control if management cannot prevent a repeat of the 31% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Ituran Location and Control's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. While Ituran Location and Control has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Ituran Location and Control produced sturdy free cash flow equating to 76% 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.

Summing up

Although Ituran Location and Control's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$6.97m. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in US$48m. So we don't have any problem with Ituran Location and Control's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Ituran Location and Control (of which 1 is concerning!) 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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