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. As with many other companies Valeo SA (EPA:FR) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Valeo
What Is Valeo's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 Valeo had €6.03b of debt, an increase on €5.21b, over one year. However, because it has a cash reserve of €2.12b, its net debt is less, at about €3.91b.
How Strong Is Valeo's Balance Sheet?
According to the last reported balance sheet, Valeo had liabilities of €8.20b due within 12 months, and liabilities of €5.65b due beyond 12 months. Offsetting these obligations, it had cash of €2.12b as well as receivables valued at €2.13b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €9.60b.
When you consider that this deficiency exceeds the company's €7.82b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Valeo'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.
In the last year Valeo had a loss before interest and tax, and actually shrunk its revenue by 12%, to €17b. We would much prefer see growth.
Caveat Emptor
Not only did Valeo's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost €99m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of €755m over the last twelve months. So suffice it to say we consider the stock to be risky. 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Valeo you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. 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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About ENXTPA:FR
Valeo
Designs, produces, and sells products and systems for automakers in France, other European countries, Africa, North America, South America, and Asia.
Good value slight.
