Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Itron, Inc. (NASDAQ:ITRI) uses debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Itron
What is Itron’s debt?
You can click on the chart below for historical numbers, but it shows Itron had $449.6 million in debt in September 2021, up from $1.34 billion a year prior. On the other hand, he has $188.7 million in cash, resulting in a net debt of around $260.9 million.
How healthy is Itron’s balance sheet?
The latest balance sheet data shows Itron had liabilities of $495.8 million due within the year, and liabilities of $727.2 million due thereafter. As compensation for these obligations, it had cash of US$188.7 million and receivables valued at US$321.0 million due within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $713.3 million.
While that might sound like a lot, it’s not too bad since Itron has a market capitalization of US$2.76 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Even though Itron’s debt is only 1.5, its interest coverage is really very low at 2.3. The main reason for this is that it has such high depreciation and amortization. While companies often boast that these fees are not cash, most of these companies will therefore require an ongoing investment (which is not spent). In any case, there is no doubt that the stock uses significant leverage. Notably, Itron’s EBIT has been fairly stable over the past year. We would prefer to see some earnings growth as this always helps reduce debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Itron can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Itron has generated free cash flow of a very strong 96% of EBIT, more than we expected. This puts him in a very strong position to repay his debt.
Our point of view
Based on our analysis, Itron’s conversion of EBIT to free cash flow should indicate that it won’t have too many debt issues. But the other factors we noted above weren’t so encouraging. To be precise, he seems about as good at covering his interest costs with his EBIT as wet socks are at keeping your feet warm. When we consider all the elements mentioned above, it seems to us that Itron manages its debt rather well. But be warned: we believe debt levels are high enough to warrant continued monitoring. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example – Itron has 2 warning signs we think you should know.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.