Does Vatti (SZSE:002035) Have A Healthy Balance Sheet?

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, Vatti Corporation Limited (SZSE:002035) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Vatti

How Much Debt Does Vatti Carry?

The image below, which you can click on for greater detail, shows that Vatti had debt of CN¥58.6m at the end of June 2024, a reduction from CN¥126.0m over a year. However, its balance sheet shows it holds CN¥2.61b in cash, so it actually has CN¥2.55b net cash.

How Strong Is Vatti's Balance Sheet?

We can see from the most recent balance sheet that Vatti had liabilities of CN¥3.10b falling due within a year, and liabilities of CN¥34.8m due beyond that. Offsetting this, it had CN¥2.61b in cash and CN¥1.20b in receivables that were due within 12 months. So it can boast CN¥668.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Vatti could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Vatti boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Vatti grew its EBIT by 289% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Vatti can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Vatti has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Vatti actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Vatti has net cash of CN¥2.55b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥832m, being 202% of its EBIT. So is Vatti's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Vatti , and understanding them should be part of your investment process.

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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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.