We Think Vysarn (ASX:VYS) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Vysarn Limited (ASX:VYS) does carry debt. But is this debt a concern to shareholders?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Vysarn

What Is Vysarn's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Vysarn had AU$8.79m of debt, an increase on AU$8.18m, over one year. However, because it has a cash reserve of AU$8.17m, its net debt is less, at about AU$619.9k.

How Healthy Is Vysarn's Balance Sheet?

According to the last reported balance sheet, Vysarn had liabilities of AU$7.12m due within 12 months, and liabilities of AU$5.99m due beyond 12 months. Offsetting these obligations, it had cash of AU$8.17m as well as receivables valued at AU$1.10m due within 12 months. So it has liabilities totalling AU$3.84m more than its cash and near-term receivables, combined.

Given Vysarn has a market capitalization of AU$40.6m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Vysarn has a very low debt to EBITDA ratio of 0.21 so it is strange to see weak interest coverage, with last year's EBIT being only 0.82 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, Vysarn made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$318k in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Vysarn will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Vysarn saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While Vysarn's interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. But on the brighter side of life, its net debt to EBITDA leaves us feeling more frolicsome. When we consider all the factors discussed, it seems to us that Vysarn is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. We've identified 4 warning signs with Vysarn , and understanding them should be part of your investment process.

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.

If you decide to trade Vysarn, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.