We think Viohalco (EBR:VIO) is taking risks with its debt
Warren Buffett said: “Volatility is far from synonymous with risk. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Viohalco S.A. (EBR:VIO) has debt on its balance sheet. But does this debt worry shareholders?
What risk does debt carry?
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 costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Viohalco
What is Viohalco’s debt?
You can click on the graph below for historical figures, but it shows that in December 2021, Viohalco had 2.19 billion euros in debt, an increase from 1.80 billion euros, on a year. However, he also had €503.3 million in cash, so his net debt is €1.68 billion.
How strong is Viohalco’s balance sheet?
We can see from the most recent balance sheet that Viohalco had liabilities of €2.07 billion due in one year, and liabilities of €1.52 billion due beyond. In return for these obligations, it had cash of €503.3 million as well as receivables worth €711.2 million at less than 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €2.37 billion.
The deficiency here weighs heavily on the 1.04 billion euro business itself, like a child struggling under the weight of a huge backpack full of books, his gym gear and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Viohalco would likely need a major recapitalization if it were to pay its creditors today.
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). Thus, we consider debt to earnings with and without depreciation and amortization charges.
Viohalco has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 4.2 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. The silver lining is that Viohalco grew its EBIT by 119% last year, which feeds like youthful idealism. If he can keep walking on this path, he will be able to get rid of his debt with relative ease. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Viohalco will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, a company can only repay its debts with cold hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Viohalco has recorded negative free cash flow, in total. Debt is much riskier for companies with unreliable free cash flow, so shareholders must hope that past spending will produce free cash flow in the future.
Our point of view
Reflecting on Viohalco’s attempt to rein in its total liabilities, we’re certainly not enthusiastic. But on the bright side, its EBIT growth rate is a good sign and makes us more optimistic. Looking at the big picture, it seems clear to us that Viohalco’s use of debt creates risks for the business. If all goes well, this should boost returns, but on the other hand, the risk of permanent capital loss is increased by debt. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Viohalco (1 of which can’t be ignored!) that you should know about.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.