Are Imperial Stocks (CVE: IEI) Using Too Much Debt?

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Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Above all, Imperial Actions inc. (CVE: IEI) carries the 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 painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.

See our latest analysis for Imperial stocks

What is Imperial Equities Debt?

The image below, which you can click for more details, shows that in June 2021, Imperial Equities had a debt of C $ 130.5 million, compared to C $ 122.9 million in one year. Net debt is about the same because it doesn’t have a lot of cash.

TSXV: IEI Debt to equity Historical September 11, 2021

How strong is Imperial Equities’ balance sheet?

Zooming in on the latest balance sheet data, we can see that Imperial Equities had a liability of CA $ 49.2 million due within 12 months and a liability of CA $ 98.9 million beyond. In return, he had CA $ 378.0K in cash and CA $ 2.54M in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by C $ 145.2 million.

This deficit casts a shadow over the C $ 37.8 million society as a towering colossus of mere mortals. We therefore believe that shareholders should watch it closely. After all, Imperial Equities would likely need a major recapitalization if it were to pay its creditors today.

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). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Low interest coverage of 2.4 times and an unusually high net debt to EBITDA ratio of 12.7 shook our confidence in Imperial stocks like a punch in the stomach. This means that we would consider him to be in heavy debt. Notably, Imperial Equities’ EBIT has been fairly stable over the past year, which is not ideal given the level of leverage. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in isolation; given that Imperial Equities will need income to service this debt. So if you want to know more about its profits, it may be worth checking out this chart of its long term profit trend.

Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years Imperial Equities has generated free cash flow of a very solid 89% of its EBIT, more than we expected. This positions it well to repay debt if it is desirable.

Our point of view

To be frank, Imperial Equities’ net debt to EBITDA and its history of staying at the top of its total liabilities makes us rather uncomfortable with its debt levels. But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Overall, we think it’s fair to say that Imperial Equities has enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you should inquire about the 3 warning signs we spotted with Imperial Equities (including 1 which is a bit rude).

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

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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 material. Simply Wall St has no position in any of the stocks mentioned.
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