Italtile (JSE:ITE) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Italtile Limited (JSE:ITE) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Italtile

What Is Italtile's Net Debt?

The chart below, which you can click on for greater detail, shows that Italtile had R556.0m in debt in December 2022; about the same as the year before. But on the other hand it also has R830.0m in cash, leading to a R274.0m net cash position.

A Look At Italtile's Liabilities

Zooming in on the latest balance sheet data, we can see that Italtile had liabilities of R826.0m due within 12 months and liabilities of R1.12b due beyond that. Offsetting this, it had R830.0m in cash and R952.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R163.0m.

Having regard to Italtile's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the R14.7b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Italtile boasts net cash, so it's fair to say it does not have a heavy debt load!

While Italtile doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Italtile will need earnings to service that debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. Italtile may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Italtile recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Italtile has R274.0m in net cash. So we are not troubled with Italtile's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Italtile has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.