Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it can be obvious that you need to factor in debt, when you think about how risky a given stock is, because too much debt can sink a business. Mostly, Volati AB (STO: VOLO) has debt. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debt and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies constantly diluting shareholders because lenders are forcing them to raise capital at a difficult price. Of course, many companies use debt to finance growth without any negative consequences. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Discover our latest analyzes for Volati
What is Volati’s debt?
As you can see below, Volati had a debt of kr 630.0 million in March 2021, up from kr 1.52 billion a year earlier. However, he also had 138.0 million kr in cash, so his net debt was 492.0 million kr.
How strong is Volati’s balance sheet?
We can see from the most recent balance sheet that Volati had liabilities of 2.05 billion kr maturing within one year and liabilities of 1.37 billion kr beyond. In return, he had 138.0 million kr in cash and 1.04 billion kr in receivables due within 12 months. It therefore has liabilities totaling 2.25 billion kr more than its cash and short-term receivables combined.
This deficit is not that big as Volati is worth 7.94 billion crowns, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interest costs (interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
With net debt standing at just 0.77 times EBITDA, Volati is arguably rather cautious. And this view is underpinned by the strong interest coverage, with EBIT of 8.9 times last year’s interest expense. In addition, Volati has increased its EBIT by 38% over the past twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Volati can strengthen its balance sheet over time. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
Finally, a business can only pay off its debts with cash, not book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. In the past three years, Volati has actually produced more free cash flow than EBIT. There is nothing better than receiving cash to stay in the good favor of your lenders.
Our point of view
The good news is that Volati’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. And that’s just the start of the good news as its EBIT growth rate is also very encouraging. By zooming out, Volati appears to be using the debt fairly sensibly; and it nods at us. While debt comes with risk, when used wisely, it can also provide a better return on equity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. Be aware that Volati shows 2 warning signs in our investment analysis , you should know …
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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