Is Vaisala Oyj (HEL:VAIAS) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Vaisala Oyj (HEL:VAIAS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that VAIAS is potentially overvalued!

How Much Debt Does Vaisala Oyj Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Vaisala Oyj had debt of €65.0m, up from €40.1m in one year. However, it also had €52.1m in cash, and so its net debt is €12.9m.

How Strong Is Vaisala Oyj's Balance Sheet?

According to the last reported balance sheet, Vaisala Oyj had liabilities of €170.7m due within 12 months, and liabilities of €18.4m due beyond 12 months. Offsetting this, it had €52.1m in cash and €122.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €14.3m.

This state of affairs indicates that Vaisala Oyj's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the €1.42b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, Vaisala Oyj has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Vaisala Oyj has a low net debt to EBITDA ratio of only 0.15. And its EBIT easily covers its interest expense, being 33.3 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Vaisala Oyj grew its EBIT by 34% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Vaisala Oyj's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Vaisala Oyj's free cash flow amounted to 48% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Vaisala Oyj's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Vaisala Oyj seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Vaisala Oyj, 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.