Here's Why Vita Group (ASX:VTG) Can Manage Its Debt Responsibly

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. As with many other companies Vita Group Limited (ASX:VTG) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Vita Group

What Is Vita Group's Debt?

As you can see below, Vita Group had AU$7.16m of debt at June 2021, down from AU$12.7m a year prior. But on the other hand it also has AU$38.2m in cash, leading to a AU$31.0m net cash position.

A Look At Vita Group's Liabilities

According to the last reported balance sheet, Vita Group had liabilities of AU$94.9m due within 12 months, and liabilities of AU$36.3m due beyond 12 months. On the other hand, it had cash of AU$38.2m and AU$23.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$69.2m.

Vita Group has a market capitalization of AU$132.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Vita Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Vita Group has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Vita Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Vita Group 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, Vita Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Vita Group does have more liabilities than liquid assets, it also has net cash of AU$31.0m. And it impressed us with free cash flow of AU$37m, being 141% of its EBIT. So we are not troubled with Vita Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Vita Group you should be aware of, and 1 of them is significant.

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.

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.

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