Does Velgraf Asset Management AD (BUL:1VX) Have A Healthy Balance Sheet?

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. Importantly, Velgraf Asset Management AD (BUL:1VX) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

View our latest analysis for Velgraf Asset Management AD

How Much Debt Does Velgraf Asset Management AD Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Velgraf Asset Management AD had лв28.7m of debt, an increase on лв19.8m, over one year. However, it also had лв1.84m in cash, and so its net debt is лв26.8m.

A Look At Velgraf Asset Management AD's Liabilities

Zooming in on the latest balance sheet data, we can see that Velgraf Asset Management AD had liabilities of лв20.7m due within 12 months and liabilities of лв20.3m due beyond that. On the other hand, it had cash of лв1.84m and лв32.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by лв6.97m.

Since publicly traded Velgraf Asset Management AD shares are worth a total of лв281.4m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

As it happens Velgraf Asset Management AD has a fairly concerning net debt to EBITDA ratio of 6.6 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Pleasingly, Velgraf Asset Management AD is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 413% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Velgraf Asset Management AD's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Velgraf Asset Management AD saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We weren't impressed with Velgraf Asset Management AD's net debt to EBITDA, and its conversion of EBIT to free cash flow made us cautious. But its interest cover was significantly redeeming. Considering this range of data points, we think Velgraf Asset Management AD is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. To that end, you should be aware of the 2 warning signs we've spotted with Velgraf Asset Management AD .

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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