We Think VSE (NASDAQ:VSEC) Is Taking Some Risk With Its Debt

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. Importantly, VSE Corporation (NASDAQ:VSEC) does carry debt. But the more important question is: how much risk is that debt creating?

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When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

How Much Debt Does VSE Carry?

As you can see below, VSE had US$430.2m of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$29.0m in cash offsetting this, leading to net debt of about US$401.1m.

A Look At VSE's Liabilities

We can see from the most recent balance sheet that VSE had liabilities of US$281.8m falling due within a year, and liabilities of US$464.6m due beyond that. Offsetting this, it had US$29.0m in cash and US$227.5m in receivables that were due within 12 months. So it has liabilities totalling US$489.9m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since VSE has a market capitalization of US$2.32b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

Check out our latest analysis for VSE

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

VSE's debt is 3.1 times its EBITDA, and its EBIT cover its interest expense 2.9 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. However, one redeeming factor is that VSE grew its EBIT at 12% over the last 12 months, boosting its ability to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if VSE can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, VSE burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

VSE's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its EBIT growth rate is relatively strong. Taking the abovementioned factors together we do think VSE's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for VSE (2 make us uncomfortable!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.