Here's Why Verbio (ETR:VBK) Has A Meaningful Debt Burden

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 Verbio SE (ETR:VBK) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Verbio

What Is Verbio's Net Debt?

As you can see below, at the end of June 2024, Verbio had €199.7m of debt, up from €176.8m a year ago. Click the image for more detail. On the flip side, it has €123.2m in cash leading to net debt of about €76.6m.

How Healthy Is Verbio's Balance Sheet?

The latest balance sheet data shows that Verbio had liabilities of €215.1m due within a year, and liabilities of €234.5m falling due after that. Offsetting this, it had €123.2m in cash and €160.9m in receivables that were due within 12 months. So its liabilities total €165.5m more than the combination of its cash and short-term receivables.

Of course, Verbio has a market capitalization of €1.14b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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).

While Verbio's low debt to EBITDA ratio of 0.71 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.9 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. The modesty of its debt load may become crucial for Verbio if management cannot prevent a repeat of the 68% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Verbio 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Verbio recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Verbio's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its net debt to EBITDA was refreshing. When we consider all the factors discussed, it seems to us that Verbio is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. Case in point: We've spotted 2 warning signs for Verbio 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.