Warren Buffett said: “Volatility is far from synonymous with risk”. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Above all, Intega Group Limited (ASX: ITG) is in debt. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest analysis for Intega Group
What is Intega Group’s net debt?
You can click on the graph below for historical figures, but it shows that Intega Group had A $ 51.8 million in debt in June 2021, up from A $ 73.2 million a year earlier. However, he has A $ 19.6 million in cash offsetting this, leading to net debt of around A $ 32.1 million.
How healthy is Intega Group’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Intega Group had A $ 66.0 million liabilities due within 12 months and A $ 83.3 million liabilities beyond. In compensation for these obligations, it had cash of A $ 19.6 million as well as receivables valued at A $ 78.6 million maturing within 12 months. It therefore has a liability totaling AU $ 51.0 million more than its cash and short-term receivables combined.
This deficit is not that big as Intega Group is worth A $ 248.9 million, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
Looking at its net debt over EBITDA of 1.2 and interest coverage of 2.8 times, it seems to us that Intega Group is probably using debt in a fairly reasonable way. We therefore recommend that you keep a close eye on the impact of financing costs on the business. Notably, Intega Group’s EBIT was higher than Elon Musk’s, gaining a whopping 209% from last year. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in isolation; given that Intega Group will need revenue to service this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business can only pay off its debts with hard cash, not with book profits. We must therefore clearly verify whether this EBIT generates a corresponding free cash flow. Fortunately for all shareholders, Intega Group has actually generated more free cash flow than EBIT over the past three years. This kind of cash conversion makes us as excited as the crowd when the pace drops at a Daft Punk concert.
Our point of view
Fortunately, the impressive conversion of EBIT into free cash flow for the Intega Group means that it has the upper hand over its debt. But the hard truth is that we are concerned about its coverage of interest. Zooming out, Intega Group appears to be using debt quite reasonably; and that gets the nod from us. After all, reasonable leverage can increase returns on equity. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 2 warning signs for Intega Group (1 is significant) you must be aware.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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