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.' 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 VDM Group Limited (ASX:VMG) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is VDM Group's Debt?
As you can see below, VDM Group had AU$9.81m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had AU$1.95m in cash, and so its net debt is AU$7.87m.
How Strong Is VDM Group's Balance Sheet?
According to the balance sheet data, VDM Group had liabilities of AU$15.5m due within 12 months, but no longer term liabilities. On the other hand, it had cash of AU$1.95m and AU$40.0k worth of receivables due within a year. So it has liabilities totalling AU$13.6m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of AU$20.8m, so it does suggest shareholders should keep an eye on VDM Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 VDM Group 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.
In the last year VDM Group wasn't profitable at an EBIT level, but managed to grow its revenue by 233%, to AU$726k. When it comes to revenue growth, that's like nailing the game winning 3-pointer!
While we can certainly appreciate VDM Group's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost AU$521k at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through AU$1.6m of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for VDM Group (1 is a bit unpleasant!) that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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