Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies Valmet Oyj (HEL: VALMT) uses the debt. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest review for Valmet Oyj
What is the debt of Valmet Oyj?
As you can see below, at the end of June 2021, Valmet Oyj had a debt of 417.0 million euros, up from 296.0 million euros a year ago. Click on the image for more details. But he also has 485.0 million euros in cash to make up for that, which means he has 68.0 million euros in net cash.
How strong is Valmet Oyj’s balance sheet?
The most recent balance sheet shows that Valmet Oyj had liabilities of 2.48 billion euros due within one year and liabilities of 520.0 million euros due beyond. In return, it had € 485.0 million in cash and € 951.0 million in receivables due within 12 months. Its liabilities thus exceed the sum of its cash and its receivables (short term) by 1.56 billion euros.
Valmet Oyj has a market cap of € 4.90 billion, so it could most likely raise cash to improve its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky. Despite her notable liabilities, Valmet Oyj has a net cash flow, so it’s fair to say that she doesn’t have a heavy debt load!
On top of that, Valmet Oyj has increased its EBIT by 31% over the past twelve months, and this growth will make it easier to process its debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Valmet Oyj can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. Although Valmet Oyj has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it’s building ( or erodes) this cash balance. In the past three years, Valmet Oyj has actually generated more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.
Although Valmet Oyj has more liabilities than liquid assets, it also has net cash of € 68.0 million. The icing on the cake is that he converted 124% of that EBIT into free cash flow, bringing in 444 million euros. We therefore do not believe that Valmet Oyj’s use of debt is risky. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. To do this, you need to know the 1 warning sign we spotted with Valmet Oyj.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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