Is TVA Group (TSE:TVA.B) Using Too Much Debt?

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 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. Importantly, TVA Group Inc. (TSE:TVA.B) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for TVA Group

What Is TVA Group's Net Debt?

The image below, which you can click on for greater detail, shows that TVA Group had debt of CA$27.2m at the end of March 2021, a reduction from CA$35.5m over a year. On the flip side, it has CA$2.36m in cash leading to net debt of about CA$24.9m.

How Healthy Is TVA Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that TVA Group had liabilities of CA$249.1m due within 12 months and liabilities of CA$21.3m due beyond that. Offsetting these obligations, it had cash of CA$2.36m as well as receivables valued at CA$165.6m due within 12 months. So it has liabilities totalling CA$102.5m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CA$112.3m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

TVA Group has a low net debt to EBITDA ratio of only 0.34. And its EBIT easily covers its interest expense, being 33.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that TVA Group has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. 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 TVA 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. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, TVA Group recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that TVA Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its level of total liabilities does undermine this impression a bit. Taking all this data into account, it seems to us that TVA Group takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for TVA Group that you should be aware of before investing here.

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.

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