We think Tetra Tech (NASDAQ:TTEK) can manage debt with ease
Warren Buffett said: “Volatility is far from synonymous with risk. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies Tetra Tech, Inc. (NASDAQ: TTEK) uses debt. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
What is Tetra Tech’s debt?
As you can see below, Tetra Tech had a debt of US$221.9 million in October 2021, compared to US$307.2 million the previous year. However, he also had $166.6 million in cash, so his net debt is $55.3 million.
How healthy is Tetra Tech’s balance sheet?
We can see from the most recent balance sheet that Tetra Tech had liabilities of US$848.5 million due in one year, and liabilities of US$493.8 million due beyond. On the other hand, it had liquidities of 166.6 million dollars and 787.0 million dollars of accounts receivable within one year. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $388.7 million.
Given that Tetra Tech has a market capitalization of US$7.77 billion, it’s hard to believe that these liabilities pose a big threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future. Carrying virtually no net debt, Tetra Tech has indeed a very light indebtedness.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). 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 ).
Tetra Tech has a low net debt to EBITDA ratio of just 0.18. And its EBIT easily covers its interest charges, which is 23.4 times the size. So we’re pretty relaxed about his super-conservative use of debt. And we also warmly note that Tetra Tech increased its EBIT by 13% last year, making its debt more manageable. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Tetra Tech can strengthen its balance sheet over time. So if you want to see what the pros think, you might find this free analyst earnings forecast report Be interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual 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
Fortunately, Tetra Tech’s impressive interest coverage means it has the upper hand on its debt. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Considering this range of factors, we believe that Tetra Tech is rather cautious with its leverage, and the risks appear to be well contained. The balance sheet therefore seems rather healthy to us. 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. To this end, you should be aware of the 2 warning signs we spotted with Tetra Tech .
If after all this you are more interested in a fast growing company with a strong balance sheet, then check out our list of net cash growth stocks without delay.
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