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. Above all, Tetra Tech, Inc. (NASDAQ: TTEK) is in debt. But should shareholders worry about its use of debt?
When is debt a problem?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Tetra Tech
What is Tetra Tech’s debt?
You can click on the chart below for historical numbers, but it shows Tetra Tech had $251.8 million in debt in April 2022, up from $279.3 million a year prior. However, he also had $194.4 million in cash, so his net debt is $57.4 million.
A look at Tetra Tech’s responsibilities
The latest balance sheet data shows Tetra Tech had liabilities of $855.2 million due within the year, and liabilities of $545.8 million due thereafter. On the other hand, it had liquid assets of 194.4 million dollars and 786.6 million dollars of receivables within one year. Thus, its liabilities total $420.0 million more than the combination of its cash and short-term receivables.
Given that Tetra Tech has a market capitalization of US$6.41 billion, it’s hard to believe that these liabilities pose a big threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate. Carrying virtually no net debt, Tetra Tech has indeed a very light indebtedness.
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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Tetra Tech’s net debt is only 0.17 times its EBITDA. And its EBIT covers its interest charges 26.0 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Another good thing is that Tetra Tech has increased its EBIT by 20% over the past year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Tetra Tech’s 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.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Tetra Tech has actually produced more free cash flow than EBIT. 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
The good news is that Tetra Tech’s demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Given this range of factors, we believe that Tetra Tech is fairly cautious with its leverage, and the risks appear well contained. The balance sheet therefore seems rather healthy to us. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we found 2 warning signs for Tetra Tech which you should be aware of before investing here.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.