Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu doesn’t care when he says, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital ”. It is natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. Mostly, Vysarn Limited (ASX: VYS) is in debt. But does this debt worry shareholders?
When is debt a problem?
Generally speaking, debt only becomes a real problem when a business cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, debt can be an important tool in businesses, especially large cap companies. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Discover our latest analyzes for Vysarn
What is Vysarn’s net debt?
You can click on the graph below for historical figures, but it shows that as of December 2020, Vysarn was in debt of A $ 8.79 million, an increase of A $ 8.18 million over one year. . However, because he has a cash reserve of A $ 8.17 million, his net debt is less, at around A $ 619.9 thousand.
How healthy is Vysarn’s track record?
According to the latest published balance sheet, Vysarn had liabilities of A $ 7.12 million due within 12 months and liabilities of A $ 5.99 million due beyond 12 months. In return for these obligations, he had cash of A $ 8.17 million as well as receivables valued at A $ 1.10 million due within 12 months. It therefore has liabilities totaling AU $ 3.84 million more than its cash and short-term receivables combined.
Considering that Vysarn has a market cap of A $ 40.6 million, it’s hard to believe that these liabilities pose a significant threat. Having said that, it is clear that we must continue to monitor his record lest it get worse.
We use two main ratios to tell us about leverage versus earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt over EBITDA) and the actual interest charges associated with that debt (with its interest coverage ratio).
Vysarn has a very low debt-to-EBITDA ratio of 0.21, so it’s strange to see low interest coverage as last year’s EBIT was only 0.82 times interest expense. So while we’re not necessarily alarmed, we think his debt is far from trivial. Notably, Vysarn recorded a loss in EBIT last year, but improved this to a positive EBIT of AU $ 318,000 over the past twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at the debt in total isolation; since Vysarn will need income to pay off this debt. So when you consider debt, it’s really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business can only pay off its debts with cash, not book profits. It is therefore important to check to what extent its profit before interest and taxes (EBIT) is converted into actual free cash flow. Over the past year, Vysarn has experienced substantial negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
While Vysarn’s interest coverage makes us cautious about this, its record of converting EBIT to free cash flow is no better. But on the brighter side of life, his net debt to EBITDA makes us feel more insane. When we consider all of the factors discussed, it seems to us that Vysarn is taking risks with his use of debt. While this debt can increase returns, we believe the company now has sufficient leverage. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. We have identified 4 warning signs with Vysarn, and understanding them should be part of your investment process.
If, after all of that, you’re more interested in a fast-growing company with a rock-solid balance sheet, then take a quick look at our list of cash-flow-growing stocks.
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