David Eben put it well: “Volatility is not a risk we care about.” Our focus is to avoid permanent loss of capital. '' It's only natural to consider a company's balance sheet when you consider how risky it is, because debt is often involved when a business collapses. Like many other companies Tetra Tech Co., Ltd. (NASDAQ:TTEK) uses debt. But should shareholders be worried about the use of debt?
Why does debt pose a risk?
Generally, 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. If things get very bad, lenders may seize the business. While this is not very common, we often see indebted companies permanently diluting shareholders because lenders force them to raise capital at distressed prices. However, as an alternative to dilution, debt can be an extremely good tool for companies that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first consider cash and debt together.
Check out our latest analysis for Tetra Tech.
What is Tetra Tech's debt?
The image below, which you can click on for greater detail, shows that Tetra Tech had debt of US$951m at the end of March 2024, down from US$1.08b, over a year ago. However, it also had US$210.3m in cash, leading to net debt of US$740.7m.
Overview of Tetra Tech's debt
The most recent balance sheet shows that Tetra Tech had liabilities of US$1.19b falling due within a year, and liabilities of US$1.29b falling due beyond that. On the other hand, it had cash of US$210.3m and US$1.14b worth of receivables due within a year. This means that it has liabilities of US$1.13b more than the combination of its cash and short-term receivables.
Of course, Tetra Tech has a massive market capitalization of US$11.7b, so these debts are probably manageable. However, we recommend shareholders continue to monitor the balance sheet, as it has ample debt.
To determine how much debt a company has relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA), and its earnings before interest, tax, and amortization (EBIT) divided by its interest expense. (its interest cover). The advantage of this approach is that it takes into account both the absolute amount of debt (net debt to EBITDA) and the actual interest expense associated with that debt (interest cover ratio).
Tetra Tech's net debt is just 1.4x its EBITDA, suggesting it's not a reckless borrower. And this view is supported by solid interest coverage, with last year's EBIT accounting for 9.8x interest expense. Another good sign is that Tetra Tech was able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, Tetra Tech's ability to strengthen its balance sheet over the long term will depend on the future profitability of its business. So if you want to see what the experts think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while tax preparers may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the past three years, Tetra Tech recorded free cash flow equivalent to 80% of its EBIT. This is more powerful than normally expected. This puts the company in a very favorable position to repay its debt.
Our take
The good news is that Tetra Tech has a proven ability to convert EBIT to free cash flow, which delights us just like a fluffy puppy does to a toddler. And the good news doesn't stop there; its EBIT growth rate backs up that impression. Overall, Tetra Tech's debt load doesn't seem to be that significant, so we don't think the company is taking on bad risk. Therefore, we're not worried about the company having a bit of leverage on its balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But not all investment risk resides within the balance sheet, far from it. For example, we found that: 3 warning signs for Tetra Tech What you need to know before investing here.
If you're more interested in fast-growing companies with rock-solid balance sheets, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. We provide commentary using only unbiased methodology, based on historical data and analyst forecasts, and our articles are not intended as financial advice. This is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. We aim to provide long-term, focused analysis based on fundamental data. Note that our analysis may not factor in the latest announcements or qualitative material from price-sensitive companies. Simply Wall St has no position in any stocks mentioned.