These 4 Measures Indicate That Vicplas International (SGX:569) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Vicplas International Ltd (SGX:569) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

View our latest analysis for Vicplas International

What Is Vicplas International's Debt?

You can click the graphic below for the historical numbers, but it shows that as of January 2021 Vicplas International had S$12.5m of debt, an increase on S$11.0m, over one year. On the flip side, it has S$5.20m in cash leading to net debt of about S$7.26m.

A Look At Vicplas International's Liabilities

According to the last reported balance sheet, Vicplas International had liabilities of S$29.0m due within 12 months, and liabilities of S$6.35m due beyond 12 months. Offsetting these obligations, it had cash of S$5.20m as well as receivables valued at S$41.7m due within 12 months. So it can boast S$11.6m more liquid assets than total liabilities.

This surplus suggests that Vicplas International has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Vicplas International's net debt is only 0.59 times its EBITDA. And its EBIT easily covers its interest expense, being 12.8 times the size. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Vicplas International saw its EBIT decline by 6.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Vicplas International 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Vicplas International 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

Based on what we've seen Vicplas International is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. It's also worth noting that Vicplas International is in the Medical Equipment industry, which is often considered to be quite defensive. Considering this range of data points, we think Vicplas International is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. To that end, you should be aware of the 3 warning signs we've spotted with Vicplas International .

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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