Vitrolife (STO:VITR) Seems To Use Debt Quite Sensibly

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.' 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. We can see that Vitrolife AB (publ) (STO:VITR) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out the opportunities and risks within the SE Biotechs industry.

How Much Debt Does Vitrolife Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Vitrolife had kr2.23b of debt, an increase on none, over one year. On the flip side, it has kr444.0m in cash leading to net debt of about kr1.79b.

How Strong Is Vitrolife's Balance Sheet?

The latest balance sheet data shows that Vitrolife had liabilities of kr748.0m due within a year, and liabilities of kr3.17b falling due after that. Offsetting these obligations, it had cash of kr444.0m as well as receivables valued at kr488.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr2.99b.

Since publicly traded Vitrolife shares are worth a total of kr21.5b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that Vitrolife's moderate net debt to EBITDA ratio ( being 2.2), indicates prudence when it comes to debt. And its commanding EBIT of 14.7 times its interest expense, implies the debt load is as light as a peacock feather. If Vitrolife can keep growing EBIT at last year's rate of 14% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Vitrolife 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. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Vitrolife recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Vitrolife's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, Vitrolife seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Vitrolife you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.