ORIOR (VTX:ORON) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, '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. We can see that ORIOR AG (VTX:ORON) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for ORIOR

What Is ORIOR's Debt?

As you can see below, ORIOR had CHF169.0m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have CHF18.3m in cash offsetting this, leading to net debt of about CHF150.7m.

How Healthy Is ORIOR's Balance Sheet?

The latest balance sheet data shows that ORIOR had liabilities of CHF106.0m due within a year, and liabilities of CHF204.9m falling due after that. Offsetting these obligations, it had cash of CHF18.3m as well as receivables valued at CHF68.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF224.5m.

While this might seem like a lot, it is not so bad since ORIOR has a market capitalization of CHF543.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

ORIOR has net debt to EBITDA of 3.2 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 9.3 times its interest expense, and its net debt to EBITDA, was quite high, at 3.2. Shareholders should be aware that ORIOR's EBIT was down 44% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine ORIOR'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, ORIOR actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Neither ORIOR's ability to grow its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. We think that ORIOR's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with ORIOR , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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