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 may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies international paper company (NYSE:IP) uses debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. 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 costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for International Paper
How much debt does international paper carry?
As you can see below, International Paper had US$5.60 billion in debt as of March 2022, up from US$7.89 billion the previous year. However, he has $1.32 billion in cash to offset this, resulting in a net debt of approximately $4.28 billion.
How strong is International Paper’s balance sheet?
According to the last published balance sheet, International Paper had liabilities of US$4.14 billion due within 12 months and liabilities of US$12.1 billion due beyond 12 months. On the other hand, it had liquidities of 1.32 billion dollars and 3.85 billion dollars of receivables at less than one year. Thus, its liabilities total $11.1 billion more than the combination of its cash and short-term receivables.
That’s a mountain of leverage, even compared to its gargantuan market capitalization of US$17.9 billion. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its 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 ).
International Paper has net debt worth 1.5x EBITDA, which isn’t too much, but its interest coverage looks a little low, with EBIT at just 5.4x expense. interests. While these numbers don’t alarm us, it’s worth noting that the cost of corporate debt has a real impact. We note that International Paper has grown its EBIT by 27% over the past year, which should make it easier to pay down debt in the future. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether International Paper can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Fortunately for all shareholders, International Paper 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
International Paper’s conversion of EBIT to free cash flow suggests it can manage its debt as easily as Cristiano Ronaldo could score a goal against an under-14 goalkeeper. But truth be told, we think his total passive level undermines that impression a bit. Given all of this data, it seems to us that International Paper is taking a pretty sensible approach to debt. While this carries some risk, it can also improve shareholder returns. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Be aware that International Paper displays 1 warning sign in our investment analysis you should know…
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.