Health Check: How Prudently Does Village VanguardLTD (TYO:2769) Use 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.' 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 Village Vanguard CO.,LTD. (TYO:2769) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 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.

Check out our latest analysis for Village VanguardLTD

How Much Debt Does Village VanguardLTD Carry?

You can click the graphic below for the historical numbers, but it shows that as of August 2020 Village VanguardLTD had JP¥12.5b of debt, an increase on JP¥9.01b, over one year. On the flip side, it has JP¥6.12b in cash leading to net debt of about JP¥6.37b.

A Look At Village VanguardLTD's Liabilities

Zooming in on the latest balance sheet data, we can see that Village VanguardLTD had liabilities of JP¥9.81b due within 12 months and liabilities of JP¥8.29b due beyond that. On the other hand, it had cash of JP¥6.12b and JP¥1.29b worth of receivables due within a year. So its liabilities total JP¥10.7b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of JP¥7.51b, we think shareholders really should watch Village VanguardLTD's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Village VanguardLTD 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.

Over 12 months, Village VanguardLTD made a loss at the EBIT level, and saw its revenue drop to JP¥28b, which is a fall of 17%. We would much prefer see growth.

Caveat Emptor

Not only did Village VanguardLTD's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost JP¥629m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through JP¥21m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Village VanguardLTD , and understanding them should be part of your investment process.

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. 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.
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