Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Villars Holding S.A. (VTX:VILN) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Villars Holding Carry?
As you can see below, at the end of June 2019, Villars Holding had CHF14.6m of debt, up from CHF15.0 a year ago. Click the image for more detail. But on the other hand it also has CHF34.7m in cash, leading to a CHF20.1m net cash position.
How Strong Is Villars Holding's Balance Sheet?
We can see from the most recent balance sheet that Villars Holding had liabilities of CHF8.34m falling due within a year, and liabilities of CHF14.6m due beyond that. Offsetting this, it had CHF34.7m in cash and CHF4.50m in receivables that were due within 12 months. So it actually has CHF16.2m more liquid assets than total liabilities.
It's good to see that Villars Holding has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Villars Holding has more cash than debt is arguably a good indication that it can manage its debt safely.
But the bad news is that Villars Holding has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Villars Holding'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Villars Holding has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Villars Holding generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case Villars Holding has CHF20.1m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in CHF1.9m. So is Villars Holding's debt a risk? It doesn't seem so to us. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Villars Holding , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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