Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Willamette Valley Vineyards, Inc. (NASDAQ:WVVI) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Willamette Valley Vineyards's Net Debt?
As you can see below, Willamette Valley Vineyards had US$7.35m of debt at September 2020, down from US$7.86m a year prior. But it also has US$10.7m in cash to offset that, meaning it has US$3.36m net cash.
A Look At Willamette Valley Vineyards's Liabilities
According to the last reported balance sheet, Willamette Valley Vineyards had liabilities of US$10.7m due within 12 months, and liabilities of US$13.2m due beyond 12 months. On the other hand, it had cash of US$10.7m and US$3.76m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$9.45m.
This deficit isn't so bad because Willamette Valley Vineyards is worth US$31.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Willamette Valley Vineyards boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Willamette Valley Vineyards grew its EBIT at 16% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Willamette Valley Vineyards's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Willamette Valley Vineyards may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Willamette Valley Vineyards saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Although Willamette Valley Vineyards's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$3.36m. And it impressed us with its EBIT growth of 16% over the last year. So we don't have any problem with Willamette Valley Vineyards's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Willamette Valley Vineyards (1 is significant!) that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.