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.' 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 Vivendi SE (EPA:VIV) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Vivendi's Net Debt?
As you can see below, Vivendi had €6.40b of debt at December 2020, down from €6.94b a year prior. On the flip side, it has €1.11b in cash leading to net debt of about €5.29b.
How Healthy Is Vivendi's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Vivendi had liabilities of €13.3b due within 12 months and liabilities of €8.38b due beyond that. On the other hand, it had cash of €1.11b and €5.61b worth of receivables due within a year. So its liabilities total €15.0b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Vivendi has a huge market capitalization of €32.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Vivendi has a debt to EBITDA ratio of 2.7, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 37.7 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Vivendi grew its EBIT by 2.6% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. 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 Vivendi'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Vivendi produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
On our analysis Vivendi's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit handle its debt, based on its EBITDA,. When we consider all the elements mentioned above, it seems to us that Vivendi is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Vivendi 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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