These 4 metrics indicate that Imperial Brands (LON:IMB) is using debt reasonably well

David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the 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. We can see that Imperial Marks PLC (LON:IMB) uses debt in its operations. But does this debt worry shareholders?

When is debt a problem?

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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Check out our latest analysis for Imperial Marks

How much debt does Imperial Brands have?

As you can see below, Imperial Brands had a debt of £9.70 billion in March 2022, up from £11.0 billion the previous year. On the other hand, he has £588.0m in cash, resulting in a net debt of around £9.11bn.

LSE: IMB Debt to equity June 9, 2022

How strong is Imperial Brands’ balance sheet?

Zooming in on the latest balance sheet data, we can see that Imperial Brands had liabilities of £11.2bn due within 12 months and liabilities of £11.1bn due beyond. On the other hand, it had cash of £588.0 million and £2.55 billion of receivables due within a year. It therefore has liabilities totaling £19.1 billion more than its cash and short-term receivables, combined.

Given that this deficit is actually higher than the company’s massive market capitalization of £17.0 billion, we think shareholders really should be watching Imperial Brands’ debt levels, like a parent watching her child riding a bike for the first time. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.

We measure a company’s leverage against its earning power 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 charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

We would say that Imperial Brands’ moderate net debt to EBITDA ratio (2.5) is indicative of leverage caution. And its towering EBIT of 1,000 times its interest expense means that the debt burden is as light as a peacock feather. Imperial Brands has increased its EBIT by 5.0% over the past year. While that barely brings us down, it’s a positive when it comes to debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Imperial Brands’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Fortunately for all shareholders, Imperial Brands has actually produced more free cash flow than EBIT for the past three years. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our point of view

Imperial Brands’ interest coverage was a real plus in this analysis, as was its conversion of EBIT to free cash flow. But truth be told, his total passive level had us biting our nails. Looking at all this data, we feel a bit cautious about Imperial Brands’ debt levels. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels might make the stock more risky. 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, we found 3 warning signs for imperial marks (1 is potentially serious!) which you should be aware of before investing here.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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.

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