These 4 Measures Indicate That Vertoz Advertising (NSE:VERTOZ) Is Using Debt Extensively

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Vertoz Advertising Limited (NSE:VERTOZ) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Vertoz Advertising

What Is Vertoz Advertising's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Vertoz Advertising had debt of ₹116.1m, up from ₹104.9m in one year. However, because it has a cash reserve of ₹31.5m, its net debt is less, at about ₹84.6m.

A Look At Vertoz Advertising's Liabilities

Zooming in on the latest balance sheet data, we can see that Vertoz Advertising had liabilities of ₹233.2m due within 12 months and liabilities of ₹32.5m due beyond that. On the other hand, it had cash of ₹31.5m and ₹161.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹72.9m.

Since publicly traded Vertoz Advertising shares are worth a total of ₹2.19b, it seems unlikely that this level of liabilities would be a major threat. 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.

While Vertoz Advertising's debt to EBITDA ratio (3.7) suggests that it uses some debt, its interest cover is very weak, at 1.1, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Vertoz Advertising's EBIT was down 88% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Vertoz Advertising'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.

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, Vertoz Advertising burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Vertoz Advertising's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. We're quite clear that we consider Vertoz Advertising to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for Vertoz Advertising you should be aware of, and 1 of them is concerning.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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