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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Victoria plc (LON:VCP) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
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How Much Debt Does Victoria Carry?
As you can see below, at the end of March 2019, Victoria had UK£401.1m of debt, up from UK£309.1m a year ago. Click the image for more detail. However, it does have UK£66.4m in cash offsetting this, leading to net debt of about UK£334.7m.
How Strong Is Victoria's Balance Sheet?
We can see from the most recent balance sheet that Victoria had liabilities of UK£179.0m falling due within a year, and liabilities of UK£485.7m due beyond that. Offsetting these obligations, it had cash of UK£66.4m as well as receivables valued at UK£111.3m due within 12 months. So its liabilities total UK£487.0m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of UK£598.1m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Victoria has a debt to EBITDA ratio of 3.6 and its EBIT covered its interest expense 2.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. On the other hand, Victoria grew its EBIT by 23% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Victoria's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.