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.' 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. We can see that EVZ Limited (ASX:EVZ) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.
View our latest analysis for EVZ
What Is EVZ's Net Debt?
You can click the graphic below for the historical numbers, but it shows that EVZ had AU$3.40m of debt in December 2020, down from AU$4.31m, one year before. However, its balance sheet shows it holds AU$4.64m in cash, so it actually has AU$1.24m net cash.
A Look At EVZ's Liabilities
Zooming in on the latest balance sheet data, we can see that EVZ had liabilities of AU$15.7m due within 12 months and liabilities of AU$1.77m due beyond that. On the other hand, it had cash of AU$4.64m and AU$10.7m worth of receivables due within a year. So it has liabilities totalling AU$2.14m more than its cash and near-term receivables, combined.
Of course, EVZ has a market capitalization of AU$11.1m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, EVZ boasts net cash, so it's fair to say it does not have a heavy debt load!
Notably, EVZ made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$1.1m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since EVZ will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. EVZ 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 year, EVZ 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.
Summing up
Although EVZ's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$1.24m. The cherry on top was that in converted 299% of that EBIT to free cash flow, bringing in AU$3.4m. So we are not troubled with EVZ's debt use. 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 example EVZ has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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About ASX:EVZ
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