David Iben puts it well: “Volatility is not the risk we care about. What we care about is avoiding permanent loss of capital.” Debt is often involved when a company goes bankrupt, so it makes sense to consider a company's balance sheet when examining risk.Like many other companies Tetra Tech Co., Ltd. (NASDAQ:TTEK) uses debt. But should shareholders be worried about its 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.
View 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 one year. However, he also had US$210.3m in cash, resulting in his net debt of US$740.7m.
Tetra Tech's debt profile
The most recent balance sheet shows that Tetra Tech had debt of US$1.19b falling due within a year, and debt of US$1.29b falling due beyond that. On the other hand, it had cash of US$210.3m and receivables worth US$1.14b that were due within a year. So it has liabilities of US$1.13b more than its cash and short-term receivables, combined.
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 measure a company's debt 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 (interest cover ratio). Calculate. 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 coverage ratio).
With net debt of just 1.4 times its EBITDA, Tetra Tech is clearly not a reckless borrower. This view is also supported by its solid interest repayments, with EBIT over the past year being 9.8 times its interest expense. Another positive sign is that Tetra Tech has been able to grow its EBIT by 27% over twelve months, making it easy to repay its debt. The balance sheet is the focus when analysing debt. But ultimately, the future profitability of the business will determine whether Tetra Tech can strengthen its balance sheet over the long term. 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 worship 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 last three years, Tetra Tech recorded free cash flow equal to 80% of its EBIT, which is stronger than you'd typically expect. This puts the company in a very strong position to pay down its debt.
our view
The good news is that Tetra Tech has a proven ability to convert EBIT into free cash flow. They delight us in the same way that fluffy puppies do to toddlers. And the good news doesn't end there. The EBIT growth rate also supports that impression. Overall, we don't think Tetra Tech's debt burden is too high, so we don't think it's a bad risk. So we're not worried about having some leverage on our balance sheet. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet, far from it. For example, we discovered 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.
Valuation is complex, but we can help make it simple.
Check out our comprehensive analysis, including below, to see if Tetra Tech is potentially overvalued or undervalued. Fair value estimates, risks and caveats, dividends, insider trading, and financial health.
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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 analysis based on fundamental data. Please note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no involvement in any of the stocks mentioned herein.
