Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Victoria plc (LON:VCP) does carry debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Victoria Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 Victoria had UK£543.9m of debt, an increase on UK£401.1m, over one year. However, it does have UK£176.8m in cash offsetting this, leading to net debt of about UK£367.1m.
How Strong Is Victoria's Balance Sheet?
We can see from the most recent balance sheet that Victoria had liabilities of UK£258.7m falling due within a year, and liabilities of UK£703.6m due beyond that. Offsetting this, it had UK£176.8m in cash and UK£144.1m in receivables that were due within 12 months. So it has liabilities totalling UK£641.4m more than its cash and near-term receivables, combined.
This deficit casts a shadow over the UK£341.1m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Victoria would likely require a major re-capitalisation if it had to pay its creditors today. 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 Victoria'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.
Over 12 months, Victoria reported revenue of UK£622m, which is a gain of 8.3%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Importantly, Victoria had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping UK£56.7m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of UK£68.2m. In the meantime, we consider the stock to be risky. 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. For instance, we've identified 3 warning signs for Victoria (2 are a bit unpleasant) you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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