Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Vitec Software Group AB (publisher) (STO:VIT B) uses debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
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. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Vitec Software Group
What is Vitec Software Group’s debt?
The image below, which you can click on for more details, shows that Vitec Software Group had a debt of 757.4 million kr at the end of December 2021, a reduction from 1.05 billion kr year on year . However, he has 119.9 million kr in cash to offset this, resulting in a net debt of approximately 637.5 million kr.
How strong is Vitec Software Group’s balance sheet?
According to the latest published balance sheet, Vitec Software Group had liabilities of kr 621.0 million due within 12 months and liabilities of kr 1.14 billion due beyond 12 months. In compensation for these obligations, it had cash of 119.9 million kr as well as receivables valued at 276.7 million kr and payable within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of kr 1.37 billion.
Of course, Vitec Software Group has a market capitalization of 18.9 billion kr, so these liabilities are probably manageable. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
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). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Vitec Software Group has a low net debt to EBITDA ratio of just 1.4. And its EBIT covers its interest charges 13.6 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Another good sign, Vitec Software Group was able to increase its EBIT by 28% in twelve months, thus facilitating the repayment of its 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 Vitec Software Group’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.
Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Vitec Software Group 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 Vitec Software Group’s demonstrated ability to cover its interest charges with its EBIT delights us like a fluffy puppy does a toddler. And the good news doesn’t stop there, since its conversion of EBIT into free cash flow also confirms this impression! Overall, we don’t think Vitec Software Group is taking bad risks, as its leverage looks modest. So we are not worried about using a little leverage on the balance sheet. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Example: we have identified 3 warning signs for Vitec Software Group you should be aware.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.
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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.