These 4 Measures Indicate That Koninklijke Vopak (AMS:VPK) Is Using Debt Reasonably Well

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.' 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. We note that Koninklijke Vopak N.V. (AMS:VPK) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 Koninklijke Vopak

What Is Koninklijke Vopak's Net Debt?

As you can see below, Koninklijke Vopak had €2.19b of debt at June 2023, down from €2.55b a year prior. On the flip side, it has €81.0m in cash leading to net debt of about €2.10b.

How Strong Is Koninklijke Vopak's Balance Sheet?

According to the last reported balance sheet, Koninklijke Vopak had liabilities of €918.6m due within 12 months, and liabilities of €2.76b due beyond 12 months. Offsetting these obligations, it had cash of €81.0m as well as receivables valued at €282.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €3.31b.

This is a mountain of leverage relative to its market capitalization of €4.01b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Koninklijke Vopak has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 3.7 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The good news is that Koninklijke Vopak grew its EBIT a smooth 39% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Koninklijke Vopak'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Koninklijke Vopak recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Koninklijke Vopak's conversion of EBIT to free cash flow was a real positive on this analysis, as was its EBIT growth rate. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Koninklijke Vopak is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. To that end, you should be aware of the 1 warning sign we've spotted with Koninklijke Vopak .

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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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.