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.' 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. Importantly, Veidekke ASA (OB:VEI) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Veidekke Carry?
The chart below, which you can click on for greater detail, shows that Veidekke had kr808.0m in debt in September 2021; about the same as the year before. But on the other hand it also has kr3.88b in cash, leading to a kr3.07b net cash position.
A Look At Veidekke's Liabilities
According to the last reported balance sheet, Veidekke had liabilities of kr11.7b due within 12 months, and liabilities of kr3.14b due beyond 12 months. Offsetting these obligations, it had cash of kr3.88b as well as receivables valued at kr6.79b due within 12 months. So it has liabilities totalling kr4.20b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Veidekke has a market capitalization of kr17.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Veidekke boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Veidekke grew its EBIT by 58% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Veidekke 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Veidekke has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Veidekke actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Although Veidekke's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of kr3.07b. And it impressed us with free cash flow of kr1.4b, being 131% of its EBIT. So we don't think Veidekke's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. 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 Veidekke .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.