Commercial Vehicle Group (NASDAQ:CVGI) Has A Somewhat Strained Balance Sheet

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Commercial Vehicle Group, Inc. (NASDAQ:CVGI) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Commercial Vehicle Group

What Is Commercial Vehicle Group's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Commercial Vehicle Group had debt of US$179.6m, up from US$152.9m in one year. However, because it has a cash reserve of US$33.6m, its net debt is less, at about US$146.0m.

A Look At Commercial Vehicle Group's Liabilities

The latest balance sheet data shows that Commercial Vehicle Group had liabilities of US$199.6m due within a year, and liabilities of US$209.0m falling due after that. Offsetting these obligations, it had cash of US$33.6m as well as receivables valued at US$192.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$182.8m.

This is a mountain of leverage relative to its market capitalization of US$281.3m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Commercial Vehicle Group has net debt worth 2.2 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.3 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Pleasingly, Commercial Vehicle Group is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 353% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Commercial Vehicle Group'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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Commercial Vehicle Group's free cash flow amounted to 21% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Neither Commercial Vehicle Group's ability to cover its interest expense with its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. We think that Commercial Vehicle Group's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example, we've discovered 2 warning signs for Commercial Vehicle Group that you should be aware of before investing here.

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. 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.