We Think Vext Science (CSE:VEXT) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Vext Science, Inc. (CSE:VEXT) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Vext Science

How Much Debt Does Vext Science Carry?

The image below, which you can click on for greater detail, shows that Vext Science had debt of US$12.7m at the end of June 2022, a reduction from US$14.6m over a year. However, because it has a cash reserve of US$1.54m, its net debt is less, at about US$11.2m.

How Strong Is Vext Science's Balance Sheet?

According to the last reported balance sheet, Vext Science had liabilities of US$19.5m due within 12 months, and liabilities of US$11.8m due beyond 12 months. On the other hand, it had cash of US$1.54m and US$12.3m worth of receivables due within a year. So its liabilities total US$17.5m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$27.3m, so it does suggest shareholders should keep an eye on Vext Science's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Vext Science's net debt is only 0.70 times its EBITDA. And its EBIT covers its interest expense a whopping 29.6 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Vext Science has boosted its EBIT by 63%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Vext Science 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Vext Science burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Vext Science is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about Vext Science's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Vext Science is showing 1 warning sign in our investment analysis , you should know about...

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.

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

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.