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.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Valmet Oyj (HEL:VALMT) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Valmet Oyj
How Much Debt Does Valmet Oyj Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 Valmet Oyj had €296.0m of debt, an increase on €242.0m, over one year. However, it does have €583.0m in cash offsetting this, leading to net cash of €287.0m.
A Look At Valmet Oyj’s Liabilities
We can see from the most recent balance sheet that Valmet Oyj had liabilities of €1.98b falling due within a year, and liabilities of €599.0m due beyond that. On the other hand, it had cash of €583.0m and €882.0m worth of receivables due within a year. So it has liabilities totalling €1.1b more than its cash and near-term receivables, combined.
This deficit isn’t so bad because Valmet Oyj is worth €3.52b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Valmet Oyj boasts net cash, so it’s fair to say it does not have a heavy debt load!
Fortunately, Valmet Oyj grew its EBIT by 4.8% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Valmet Oyj can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Valmet Oyj may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Valmet Oyj actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing up
Although Valmet Oyj’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €287.0m. The cherry on top was that in converted 112% of that EBIT to free cash flow, bringing in €548m. So is Valmet Oyj’s debt a risk? It doesn’t seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For instance, we’ve identified 1 warning sign for Valmet Oyj that you should be aware of.
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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