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Warren Buffett famously said, ‘Volatility Is Far From Synonymous With Risk.’ So It Might Be Obvious That You Need To Consider Debt, When You Think About How Risky Any Given Stock is, because too much debt can sink a company. As with many other companies Vitec Software Group AB (publ) (STO:VIT B) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Vitec Software Group’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Vitec Software Group had kr586.7m of debt, an increase on kr498.2m, over one year. However, because it has a cash reserve of kr165.9m, its net debt is less, at about kr420.8m.
How Strong Is Vitec Software Group’s Balance Sheet?
The latest balance sheet data shows that Vitec Software Group had liabilities of kr473.3m due within a year, and liabilities of kr856.8m falling due after that. Offsetting these obligations, it had cash of kr165.9m as well as receivables valued at kr163.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr1.00b. Since publicly traded Vitec Software Group shares are worth a total of kr10.9b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Vitec Software Group has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 12.6 times the size. So we’re pretty relaxed about its super-conservative use of debt. Another good sign is that Vitec Software Group has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Vitec Software Group’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts. But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Vitec Software Group recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
Our View
The good news is that Vitec Software Group’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that’s just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Vitec Software Group is quite prudent with its debt, and the risks seem well managed. So we’re not worried about the use of a little leverage on the balance sheet. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Be aware that Vitec Software Group is showing 1 warning sign in our investment analysis , you should know about… If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This news was originally published at Simply Wall St.