Is Valeo (EPA:FR) Using Debt Sensibly?

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.' 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. As with many other companies Valeo SE (EPA:FR) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Valeo

What Is Valeo's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Valeo had debt of €5.80b, up from €4.52b in one year. However, because it has a cash reserve of €2.95b, its net debt is less, at about €2.85b.

A Look At Valeo's Liabilities

The latest balance sheet data shows that Valeo had liabilities of €9.31b due within a year, and liabilities of €5.56b falling due after that. On the other hand, it had cash of €2.95b and €3.21b worth of receivables due within a year. So it has liabilities totalling €8.70b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's €6.96b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Valeo had a loss before interest and tax, and actually shrunk its revenue by 16%, to €16b. We would much prefer see growth.

Caveat Emptor

While Valeo's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost €82m 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. For example, we would not want to see a repeat of last year's loss of €1.1b. And until that time we think this is a risky stock. 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 1 warning sign for Valeo you should be aware of.

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.

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