Does Viva Energy Group (ASX:VEA) 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Viva Energy Group Limited (ASX:VEA) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Viva Energy Group

What Is Viva Energy Group's Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Viva Energy Group had debt of AU$191.9m, up from AU$153.3m in one year. However, because it has a cash reserve of AU$103.5m, its net debt is less, at about AU$88.4m.

How Strong Is Viva Energy Group's Balance Sheet?

According to the last reported balance sheet, Viva Energy Group had liabilities of AU$2.48b due within 12 months, and liabilities of AU$2.72b due beyond 12 months. Offsetting these obligations, it had cash of AU$103.5m as well as receivables valued at AU$1.29b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$3.80b.

This deficit is considerable relative to its market capitalization of AU$4.40b, so it does suggest shareholders should keep an eye on Viva Energy Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 0.14 and interest cover of 2.6 times, it seems to us that Viva Energy Group is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably, Viva Energy Group made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$485m in the last twelve months. 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 Viva Energy Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the most recent year, Viva Energy Group recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Viva Energy Group's net debt to EBITDA was a real positive on this analysis, as was its conversion of EBIT to free cash flow. In contrast, our confidence was undermined by its apparent struggle to cover its interest expense with its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Viva Energy Group's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more 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 instance, we've identified 1 warning sign for Viva Energy Group that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.