Is Vetoquinol (EPA:VETO) 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Vetoquinol SA (EPA:VETO) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 Vetoquinol

How Much Debt Does Vetoquinol Carry?

As you can see below, Vetoquinol had €3.48m of debt at December 2022, down from €4.11m a year prior. But on the other hand it also has €93.7m in cash, leading to a €90.2m net cash position.

How Strong Is Vetoquinol's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vetoquinol had liabilities of €140.7m due within 12 months and liabilities of €26.5m due beyond that. On the other hand, it had cash of €93.7m and €91.3m worth of receivables due within a year. So it actually has €17.8m more liquid assets than total liabilities.

This state of affairs indicates that Vetoquinol'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 €1.07b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Vetoquinol boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Vetoquinol has increased its EBIT by 3.0% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Vetoquinol can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Vetoquinol may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Vetoquinol created free cash flow amounting to 20% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Vetoquinol has net cash of €90.2m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 3.0% in the last twelve months. So we are not troubled with Vetoquinol's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Vetoquinol's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.