Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Viavi Solutions Inc. (NASDAQ:VIAV) uses debt. But does this debt worry shareholders?
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Viavi Solutions
What is Viavi Solutions’ debt?
You can click on the chart below for historical numbers, but it shows that in April 2022, Viavi Solutions had $706.4 million in debt, up from $634.2 million, on a year. However, he also had $591.4 million in cash, so his net debt is $115.0 million.
How strong is Viavi Solutions’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Viavi Solutions had liabilities of US$259.7 million due within 12 months and liabilities of US$908.4 million due beyond. In compensation for these obligations, it had cash of US$591.4 million as well as receivables valued at US$289.2 million and maturing within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $287.5 million.
Given that publicly traded Viavi Solutions shares are worth a total of US$2.98 billion, it seems unlikely that this level of liability is a major threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Given its net debt to EBITDA of 0.45 and interest coverage of 5.2 times, it seems to us that Viavi Solutions is probably using debt quite sensibly. But the interest payments are certainly enough to make us think about the affordability of its debt. It should be noted that Viavi Solutions’ EBIT has jumped like bamboo after rain, gaining 33% over the last twelve months. This will make it easier to manage your debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Viavi Solutions can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Viavi Solutions has recorded free cash flow representing 94% of its EBIT, which is higher than what we would normally expect. This positions him well to pay off debt if desired.
Our point of view
Fortunately, Viavi Solutions’ impressive EBIT to free cash flow conversion means it has the upper hand on its debt. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Given this range of factors, we believe that Viavi Solutions is fairly conservative with its leverage, and the risks appear to be well contained. The balance sheet therefore seems rather healthy to us. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. To this end, you should be aware of the 2 warning signs we spotted with Viavi Solutions.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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