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. We can see that IDACORP, Inc. (NYSE:IDA) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is IDACORP's Debt?
As you can see below, at the end of December 2020, IDACORP had US$2.00b of debt, up from US$1.84b a year ago. Click the image for more detail. However, it does have US$300.1m in cash offsetting this, leading to net debt of about US$1.70b.
How Strong Is IDACORP's Balance Sheet?
The latest balance sheet data shows that IDACORP had liabilities of US$287.6m due within a year, and liabilities of US$4.24b falling due after that. Offsetting this, it had US$300.1m in cash and US$160.1m in receivables that were due within 12 months. So it has liabilities totalling US$4.07b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$5.07b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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.
IDACORP has a debt to EBITDA ratio of 3.6 and its EBIT covered its interest expense 3.1 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The good news is that IDACORP improved its EBIT by 3.6% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if IDACORP can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, IDACORP's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Both IDACORP's interest cover and its net debt to EBITDA were discouraging. But its not so bad at growing its EBIT. It's also worth noting that IDACORP is in the Electric Utilities industry, which is often considered to be quite defensive. Taking the abovementioned factors together we do think IDACORP's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. Case in point: We've spotted 1 warning sign for IDACORP you should be aware of.
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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