Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Vista Outdoor Inc. (NYSE:VSTO) does use debt in its business. But should shareholders be worried about its use of debt?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Vista Outdoor's Debt?
As you can see below, at the end of June 2021, Vista Outdoor had US$495.7m of debt, up from US$443.9m a year ago. Click the image for more detail. However, because it has a cash reserve of US$208.7m, its net debt is less, at about US$287.0m.
How Strong Is Vista Outdoor's Balance Sheet?
The latest balance sheet data shows that Vista Outdoor had liabilities of US$364.4m due within a year, and liabilities of US$686.7m falling due after that. Offsetting this, it had US$208.7m in cash and US$361.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$480.8m.
Since publicly traded Vista Outdoor shares are worth a total of US$2.41b, 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.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Vista Outdoor's net debt is only 0.66 times its EBITDA. And its EBIT easily covers its interest expense, being 14.9 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, Vista Outdoor grew its EBIT by 376% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Vista Outdoor 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.
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. During the last three years, Vista Outdoor generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Happily, Vista Outdoor's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Overall, we don't think Vista Outdoor is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. 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. We've identified 2 warning signs with Vista Outdoor (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.
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.
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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