Does Verbrec (ASX:VBC) Have A Healthy Balance Sheet?

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.' 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. Importantly, Verbrec Limited (ASX:VBC) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Verbrec

What Is Verbrec's Net Debt?

The chart below, which you can click on for greater detail, shows that Verbrec had AU$3.55m in debt in June 2020; about the same as the year before. However, it does have AU$15.9m in cash offsetting this, leading to net cash of AU$12.4m.

How Healthy Is Verbrec's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Verbrec had liabilities of AU$25.4m due within 12 months and liabilities of AU$5.62m due beyond that. On the other hand, it had cash of AU$15.9m and AU$17.6m worth of receivables due within a year. So it actually has AU$2.47m more liquid assets than total liabilities.

This surplus suggests that Verbrec has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Verbrec has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Verbrec grew its EBIT by 275% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Verbrec's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Verbrec has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Verbrec actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Verbrec has net cash of AU$12.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of AU$10m, being 156% of its EBIT. So we don't think Verbrec's use of debt is risky. 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. For example, we've discovered 2 warning signs for Verbrec that you should be aware of before investing here.

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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