Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, 21Vianet Group, Inc. (NASDAQ:VNET) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does 21Vianet Group Carry?
As you can see below, 21Vianet Group had CN¥3.24b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have CN¥3.03b in cash offsetting this, leading to net debt of about CN¥213.6m.
How Strong Is 21Vianet Group's Balance Sheet?
We can see from the most recent balance sheet that 21Vianet Group had liabilities of CN¥2.38b falling due within a year, and liabilities of CN¥5.25b due beyond that. On the other hand, it had cash of CN¥3.03b and CN¥801.2m worth of receivables due within a year. So its liabilities total CN¥3.80b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of CN¥6.31b, so it does suggest shareholders should keep an eye on 21Vianet Group's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
21Vianet Group has a very low debt to EBITDA ratio of 0.23 so it is strange to see weak interest coverage, with last year's EBIT being only 0.93 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, 21Vianet Group's EBIT launched higher than Elon Musk, gaining a whopping 230% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if 21Vianet Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent two years, 21Vianet Group recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Based on what we've seen 21Vianet Group is not finding it easy interest cover, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to grow its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that 21Vianet Group is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Even though 21Vianet Group lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending over the last few years.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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