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

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 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. We can see that CVS Group plc (LON:CVSG) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for CVS Group

How Much Debt Does CVS Group Carry?

As you can see below, at the end of June 2023, CVS Group had UK£92.2m of debt, up from UK£84.3m a year ago. Click the image for more detail. On the flip side, it has UK£21.5m in cash leading to net debt of about UK£70.7m.

How Healthy Is CVS Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CVS Group had liabilities of UK£105.1m due within 12 months and liabilities of UK£210.6m due beyond that. Offsetting these obligations, it had cash of UK£21.5m as well as receivables valued at UK£48.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£245.4m.

This deficit isn't so bad because CVS Group is worth UK£1.13b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CVS Group has net debt of just 0.73 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 7.4 times, which is more than adequate. In addition to that, we're happy to report that CVS Group has boosted its EBIT by 46%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CVS Group can strengthen its balance sheet over time. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, CVS Group generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

CVS Group's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. It's also worth noting that CVS Group is in the Healthcare industry, which is often considered to be quite defensive. Considering this range of factors, it seems to us that CVS Group is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. 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 CVS Group's earnings per share history for free.

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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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.