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.' 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. Importantly, Vista Outdoor Inc. (NYSE:VSTO) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 Vista Outdoor's Net Debt?
The chart below, which you can click on for greater detail, shows that Vista Outdoor had US$495.6m in debt in March 2021; about the same as the year before. However, it does have US$243.3m in cash offsetting this, leading to net debt of about US$252.3m.
How Healthy Is Vista Outdoor's Balance Sheet?
According to the last reported balance sheet, Vista Outdoor had liabilities of US$370.8m due within 12 months, and liabilities of US$657.1m due beyond 12 months. Offsetting this, it had US$243.3m in cash and US$339.4m in receivables that were due within 12 months. So its liabilities total US$445.2m more than the combination of its cash and short-term receivables.
Since publicly traded Vista Outdoor shares are worth a total of US$2.52b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Vista Outdoor's net debt is only 0.74 times its EBITDA. And its EBIT easily covers its interest expense, being 10.7 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Vista Outdoor grew its EBIT by 688% over twelve months. That boost will make it even easier to pay down debt going forward. 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. Happily for any shareholders, Vista Outdoor actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Happily, Vista Outdoor's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate 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. 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 instance, we've identified 4 warning signs for Vista Outdoor (1 is a bit concerning) you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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