Stock Analysis

Velocity Composites (LON:VEL) Has Debt But No Earnings; Should You Worry?

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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.' 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 note that Velocity Composites plc (LON:VEL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

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What Is Velocity Composites's Debt?

As you can see below, at the end of April 2021, Velocity Composites had UK£2.00m of debt, up from none a year ago. Click the image for more detail. But it also has UK£3.45m in cash to offset that, meaning it has UK£1.45m net cash.

AIM:VEL Debt to Equity History July 21st 2021

A Look At Velocity Composites' Liabilities

According to the last reported balance sheet, Velocity Composites had liabilities of UK£2.11m due within 12 months, and liabilities of UK£2.59m due beyond 12 months. Offsetting this, it had UK£3.45m in cash and UK£2.48m in receivables that were due within 12 months. So it can boast UK£1.23m more liquid assets than total liabilities.

This surplus suggests that Velocity Composites is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Velocity Composites has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is Velocity Composites's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Velocity Composites made a loss at the EBIT level, and saw its revenue drop to UK£8.5m, which is a fall of 61%. That makes us nervous, to say the least.

So How Risky Is Velocity Composites?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year Velocity Composites had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through UK£247k of cash and made a loss of UK£3.6m. But the saving grace is the UK£1.45m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Velocity Composites you should be aware of, and 1 of them is concerning.

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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