Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Vetrya S.p.A. (BIT:VTY) does carry debt. 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. 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 think about a company's use of debt, we first look at cash and debt together.
What Is Vetrya's Net Debt?
As you can see below, Vetrya had €5.81m of debt at December 2018, down from €6.29m a year prior. But it also has €9.17m in cash to offset that, meaning it has €3.36m net cash.
A Look At Vetrya's Liabilities
We can see from the most recent balance sheet that Vetrya had liabilities of €32.7m falling due within a year, and liabilities of €4.19m due beyond that. On the other hand, it had cash of €9.17m and €31.3m worth of receivables due within a year. So it can boast €3.59m more liquid assets than total liabilities.
This short term liquidity is a sign that Vetrya could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Vetrya has more cash than debt is arguably a good indication that it can manage its debt safely.
The good news is that Vetrya has increased its EBIT by 5.4% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Vetrya'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Vetrya 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. During the last three years, Vetrya produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case Vetrya has €3.4m in net cash and a decent-looking balance sheet. So we don't think Vetrya's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Vetrya, you may well want to click here to check an interactive graph of its earnings per share history.
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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