Is CVS Group (LON:CVSG) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, CVS Group plc (LON:CVSG) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for CVS Group

How Much Debt Does CVS Group Carry?

As you can see below, CVS Group had UK£84.1m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have UK£21.8m in cash offsetting this, leading to net debt of about UK£62.3m.

How Healthy Is CVS Group's Balance Sheet?

We can see from the most recent balance sheet that CVS Group had liabilities of UK£89.0m falling due within a year, and liabilities of UK£197.6m due beyond that. On the other hand, it had cash of UK£21.8m and UK£51.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£212.9m.

Of course, CVS Group has a market capitalization of UK£1.24b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt sitting at just 0.76 times EBITDA, CVS Group is arguably pretty conservatively geared. And it boasts interest cover of 7.1 times, which is more than adequate. On top of that, CVS Group grew its EBIT by 91% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine CVS Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, CVS Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, CVS Group's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! We would also note that Healthcare industry companies like CVS Group commonly do use debt without problems. Overall, we don't think CVS Group is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. We'd be very excited to see if CVS Group insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.