Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. Above all, Vista Outdoor Inc. (NYSE: VSTO) bears the debt. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first look at cash and debt levels together.
What is Vista Outdoor’s net debt?
The graph below, which you can click for more details, shows that Vista Outdoor had $ 495.6 million in debt as of March 2021; about the same as the year before. However, it has $ 243.3 million in cash offsetting that, which leads to net debt of around $ 252.3 million.
How healthy is Vista Outdoor’s balance sheet?
According to the latest published balance sheet, Vista Outdoor had a liability of US $ 370.8 million due within 12 months and a liability of US $ 657.1 million due beyond 12 months. In return, he had $ 243.3 million in cash and $ 339.4 million in receivables due within 12 months. Its liabilities therefore total US $ 445.2 million more than the combination of its cash and short-term receivables.
Given that Vista Outdoor’s publicly traded shares are worth a total of US $ 2.52 billion, it seems unlikely that this level of liabilities is a major threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
We measure a company’s debt load relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Vista Outdoor’s net debt is only 0.74 times its EBITDA. And its EBIT easily covers its interest costs, being 10.7 times greater. So we’re pretty relaxed about its ultra-conservative use of debt. Even more impressively, Vista Outdoor increased its EBIT by 688% year over year. This boost will make it even easier to pay down debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Vista Outdoor can strengthen its balance sheet over time. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a company cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Fortunately for all shareholders, Vista Outdoor has actually generated more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
Fortunately, Vista Outdoor’s impressive conversion of EBIT to free cash flow means it has the upper hand over its debt. And the good news doesn’t end there, because its EBIT growth rate also supports this impression! Overall, we don’t think Vista Outdoor is taking bad risks, as its debt load appears modest. The balance sheet therefore seems rather healthy to us. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 4 warning signs for Vista Outdoor (1 is a bit worrying) you must be aware.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page. free list of growing companies that have net cash on the balance sheet.
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