Voestalpine (VIE:VOE) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Voestalpine AG (VIE:VOE) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Voestalpine

What Is Voestalpine's Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Voestalpine had debt of €4.69b, up from €4.18b in one year. However, it also had €678.0m in cash, and so its net debt is €4.01b.

How Strong Is Voestalpine's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Voestalpine had liabilities of €5.50b due within 12 months and liabilities of €3.90b due beyond that. On the other hand, it had cash of €678.0m and €2.03b worth of receivables due within a year. So its liabilities total €6.68b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of €5.26b, we think shareholders really should watch Voestalpine's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Voestalpine's net debt to EBITDA ratio of about 2.1 suggests only moderate use of debt. And its commanding EBIT of 20.2 times its interest expense, implies the debt load is as light as a peacock feather. Notably, Voestalpine's EBIT launched higher than Elon Musk, gaining a whopping 404% on last year. 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 Voestalpine can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Voestalpine actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Both Voestalpine's ability to to cover its interest expense with its EBIT and its conversion of EBIT to free cash flow gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that Voestalpine is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Voestalpine is showing 3 warning signs in our investment analysis , and 1 of those is significant...

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.