We Think Verbicom (WSE:VRB) Can Stay On Top Of Its Debt

By
Simply Wall St
Published
April 12, 2022
WSE:VRB
Source: Shutterstock

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Verbicom S.A. (WSE:VRB) does have debt on its balance sheet. 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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Verbicom

What Is Verbicom's Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Verbicom had debt of zł8.28m, up from zł7.25m in one year. However, it also had zł5.55m in cash, and so its net debt is zł2.72m.

debt-equity-history-analysis
WSE:VRB Debt to Equity History April 12th 2022

How Healthy Is Verbicom's Balance Sheet?

The latest balance sheet data shows that Verbicom had liabilities of zł24.0m due within a year, and liabilities of zł4.92m falling due after that. Offsetting this, it had zł5.55m in cash and zł8.56m in receivables that were due within 12 months. So it has liabilities totalling zł14.8m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's zł12.8m market capitalization, you might well be inclined to review the balance sheet intently. 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Verbicom has a low debt to EBITDA ratio of only 0.94. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. It was also good to see that despite losing money on the EBIT line last year, Verbicom turned things around in the last 12 months, delivering and EBIT of zł1.7m. 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 Verbicom 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 it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Verbicom 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.

Our View

Both Verbicom's ability to to cover its interest expense with its EBIT and its conversion of EBIT to free cash flow gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. When we consider all the factors mentioned above, we do feel a bit cautious about Verbicom's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Verbicom , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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