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.’ 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. Importantly, New Look Vision Group Inc. (TSE:BCI) does carry debt. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does New Look Vision Group Carry?
The image below, which you can click on for greater detail, shows that New Look Vision Group had debt of CA$159.3m at the end of June 2019, a reduction from CA$166.5m over a year. However, it also had CA$7.09m in cash, and so its net debt is CA$152.2m.
A Look At New Look Vision Group’s Liabilities
We can see from the most recent balance sheet that New Look Vision Group had liabilities of CA$54.8m falling due within a year, and liabilities of CA$172.4m due beyond that. Offsetting these obligations, it had cash of CA$7.09m as well as receivables valued at CA$23.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$197.1m.
New Look Vision Group has a market capitalization of CA$500.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
New Look Vision Group’s debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 3.1 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. On a slightly more positive note, New Look Vision Group grew its EBIT at 19% over the last year, further increasing its ability to manage 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 New Look Vision 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, New Look Vision Group generated free cash flow amounting to a very robust 85% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
The good news is that New Look Vision Group’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its interest cover. Looking at all the aforementioned factors together, it strikes us that New Look Vision Group can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it’s worth monitoring the balance sheet. We’d be motivated to research the stock further if we found out that New Look Vision Group insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
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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