Is Vidrala (BME:VID) A Risky Investment?

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. We can see that Vidrala, S.A. (BME:VID) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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, 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.

View our latest analysis for Vidrala

How Much Debt Does Vidrala Carry?

As you can see below, at the end of December 2022, Vidrala had €260.9m of debt, up from €237.4m a year ago. Click the image for more detail. However, it also had €154.0m in cash, and so its net debt is €106.9m.

How Strong Is Vidrala's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vidrala had liabilities of €488.6m due within 12 months and liabilities of €431.3m due beyond that. Offsetting this, it had €154.0m in cash and €370.9m in receivables that were due within 12 months. So it has liabilities totalling €395.0m more than its cash and near-term receivables, combined.

Of course, Vidrala has a market capitalization of €3.01b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Vidrala has a low net debt to EBITDA ratio of only 0.41. And its EBIT covers its interest expense a whopping 59.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. While Vidrala doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Vidrala'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Vidrala recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Vidrala's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. When we consider the range of factors above, it looks like Vidrala is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. Over time, share prices tend to follow earnings per share, so if you're interested in Vidrala, you may well want to click here to check an interactive graph of its earnings per share history.

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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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.