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, VOXX International Corporation (NASDAQ:VOXX) does carry debt. But should shareholders be worried about its use of debt?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is VOXX International's Debt?
The image below, which you can click on for greater detail, shows that at May 2022 VOXX International had debt of US$15.4m, up from US$6.19m in one year. However, because it has a cash reserve of US$5.73m, its net debt is less, at about US$9.64m.
How Healthy Is VOXX International's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that VOXX International had liabilities of US$168.2m due within 12 months and liabilities of US$39.9m due beyond that. Offsetting these obligations, it had cash of US$5.73m as well as receivables valued at US$83.6m due within 12 months. So it has liabilities totalling US$118.7m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$170.2m, so it does suggest shareholders should keep an eye on VOXX International's use of debt. 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.
VOXX International has a very low debt to EBITDA ratio of 0.55 so it is strange to see weak interest coverage, with last year's EBIT being only 2.4 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, VOXX International's EBIT fell a jaw-dropping 80% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 VOXX International'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last two years, VOXX International burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
To be frank both VOXX International'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. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. We're quite clear that we consider VOXX International to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - VOXX International has 2 warning signs we think you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
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