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We Think IPH (ASX:IPH) Can Manage Its Debt With Ease

Simply Wall St

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, IPH Limited (ASX:IPH) does carry debt. But the more important question is: how much risk is that debt creating?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for IPH

What Is IPH's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2019 IPH had AU$65.7m of debt, an increase on AU$40.3m, over one year. However, its balance sheet shows it holds AU$74.5m in cash, so it actually has AU$8.79m net cash.

ASX:IPH Historical Debt, September 4th 2019

How Strong Is IPH's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that IPH had liabilities of AU$37.6m due within 12 months and liabilities of AU$92.6m due beyond that. Offsetting this, it had AU$74.5m in cash and AU$65.9m in receivables that were due within 12 months. So it actually has AU$10.2m more liquid assets than total liabilities.

This state of affairs indicates that IPH's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the AU$1.97b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that IPH has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that IPH has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine IPH's ability to maintain a healthy balance sheet going forward. 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. IPH 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. During the last three years, IPH produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case IPH has AU$8.8m in net cash and a decent-looking balance sheet. And we liked the look of last year's 28% year-on-year EBIT growth. So we don't think IPH's use of debt is risky. We'd be very excited to see if IPH insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.