Is Vista Alegre Atlantis SGPS (ELI:VAF) A Risky Investment?

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 Vista Alegre Atlantis, SGPS, S.A. (ELI:VAF) 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?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Vista Alegre Atlantis SGPS

How Much Debt Does Vista Alegre Atlantis SGPS Carry?

As you can see below, Vista Alegre Atlantis SGPS had €98.9m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had €7.37m in cash, and so its net debt is €91.6m.

A Look At Vista Alegre Atlantis SGPS's Liabilities

The latest balance sheet data shows that Vista Alegre Atlantis SGPS had liabilities of €68.5m due within a year, and liabilities of €98.7m falling due after that. Offsetting these obligations, it had cash of €7.37m as well as receivables valued at €21.2m due within 12 months. So its liabilities total €138.6m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of €150.9m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Weak interest cover of 0.98 times and a disturbingly high net debt to EBITDA ratio of 7.2 hit our confidence in Vista Alegre Atlantis SGPS like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Vista Alegre Atlantis SGPS's EBIT was down 61% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that 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 Vista Alegre Atlantis SGPS'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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, Vista Alegre Atlantis SGPS saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Vista Alegre Atlantis SGPS'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. And furthermore, its net debt to EBITDA also fails to instill confidence. After considering the datapoints discussed, we think Vista Alegre Atlantis SGPS has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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 4 warning signs for Vista Alegre Atlantis SGPS you should be aware of, and 1 of them doesn't sit too well with us.

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. 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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