These 4 Measures Indicate That Verra Mobility (NASDAQ:VRRM) Is Using Debt Reasonably Well

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Verra Mobility Corporation (NASDAQ:VRRM) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Verra Mobility

How Much Debt Does Verra Mobility Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Verra Mobility had US$1.22b of debt, an increase on US$972.4m, over one year. However, it does have US$100.3m in cash offsetting this, leading to net debt of about US$1.12b.

How Strong Is Verra Mobility's Balance Sheet?

According to the last reported balance sheet, Verra Mobility had liabilities of US$154.1m due within 12 months, and liabilities of US$1.39b due beyond 12 months. Offsetting these obligations, it had cash of US$100.3m as well as receivables valued at US$211.4m due within 12 months. So it has liabilities totalling US$1.24b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Verra Mobility has a market capitalization of US$2.51b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Verra Mobility has a debt to EBITDA ratio of 4.1 and its EBIT covered its interest expense 3.1 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, it should be some comfort for shareholders to recall that Verra Mobility actually grew its EBIT by a hefty 667%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. 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 Verra Mobility'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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Verra Mobility actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Verra Mobility's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its net debt to EBITDA has the opposite effect. All these things considered, it appears that Verra Mobility can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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, we've discovered 1 warning sign for Verra Mobility that you should be aware of before investing here.

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.

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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.