We Think Viro Tvornica Secera d.d (ZGSE:VIRO) Is Taking Some Risk With Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Viro Tvornica Secera d.d. (ZGSE:VIRO) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Viro Tvornica Secera d.d

How Much Debt Does Viro Tvornica Secera d.d Carry?

You can click the graphic below for the historical numbers, but it shows that Viro Tvornica Secera d.d had Kn59.5m of debt in September 2022, down from Kn94.3m, one year before. However, it also had Kn8.35m in cash, and so its net debt is Kn51.2m.

How Strong Is Viro Tvornica Secera d.d's Balance Sheet?

The latest balance sheet data shows that Viro Tvornica Secera d.d had liabilities of Kn178.9m due within a year, and liabilities of Kn21.4m falling due after that. Offsetting these obligations, it had cash of Kn8.35m as well as receivables valued at Kn66.0m due within 12 months. So it has liabilities totalling Kn126.0m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's Kn86.0m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Viro Tvornica Secera d.d has a low net debt to EBITDA ratio of only 0.90. And its EBIT covers its interest expense a whopping 71.9 times over. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Viro Tvornica Secera d.d grew its EBIT by 2,400% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Viro Tvornica Secera d.d will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Viro Tvornica Secera d.d created free cash flow amounting to 18% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

We feel some trepidation about Viro Tvornica Secera d.d's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. We think that Viro Tvornica Secera d.d's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Viro Tvornica Secera d.d (1 is potentially serious!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.