Is Vidrala (BME:VID) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Vidrala, S.A. (BME:VID) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Vidrala

What Is Vidrala's Debt?

You can click the graphic below for the historical numbers, but it shows that Vidrala had €243.4m of debt in June 2021, down from €333.1m, one year before. However, because it has a cash reserve of €108.2m, its net debt is less, at about €135.2m.

A Look At Vidrala's Liabilities

According to the last reported balance sheet, Vidrala had liabilities of €378.8m due within 12 months, and liabilities of €289.8m due beyond 12 months. On the other hand, it had cash of €108.2m and €313.0m worth of receivables due within a year. So it has liabilities totalling €247.5m more than its cash and near-term receivables, combined.

Given Vidrala has a market capitalization of €2.56b, it's hard to believe these liabilities pose much threat. 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). 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).

Vidrala has a low net debt to EBITDA ratio of only 0.45. And its EBIT covers its interest expense a whopping 67.0 times over. So we're pretty relaxed about its super-conservative use of debt. Also positive, Vidrala grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. 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 Vidrala 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. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Vidrala recorded free cash flow worth 76% 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

The good news is that Vidrala's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think Vidrala is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. 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.

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.

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.

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