Here's Why StorageVault Canada (TSE:SVI) Can Manage Its Debt Responsibly

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 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. As with many other companies StorageVault Canada Inc. (TSE:SVI) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that SVI is potentially overvalued!

What Is StorageVault Canada's Debt?

As you can see below, at the end of June 2022, StorageVault Canada had CA$1.64b of debt, up from CA$1.35b a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

A Look At StorageVault Canada's Liabilities

Zooming in on the latest balance sheet data, we can see that StorageVault Canada had liabilities of CA$23.6m due within 12 months and liabilities of CA$1.77b due beyond that. Offsetting this, it had CA$18.1m in cash and CA$5.04m in receivables that were due within 12 months. So it has liabilities totalling CA$1.77b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CA$2.38b, so it does suggest shareholders should keep an eye on StorageVault Canada's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

StorageVault Canada shareholders face the double whammy of a high net debt to EBITDA ratio (13.4), and fairly weak interest coverage, since EBIT is just 0.52 times the interest expense. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that StorageVault Canada actually grew its EBIT by a hefty 325%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if StorageVault Canada 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, StorageVault Canada actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We weren't impressed with StorageVault Canada's net debt to EBITDA, and its interest cover made us cautious. But its conversion of EBIT to free cash flow was significantly redeeming. Looking at all this data makes us feel a little cautious about StorageVault Canada's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for StorageVault Canada you should be aware of.

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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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.