The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ 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. We can see that VivoPower International PLC (NASDAQ:VVPR) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does VivoPower International Carry?
You can click the graphic below for the historical numbers, but it shows that VivoPower International had US$19.0m of debt in March 2019, down from US$22.3m, one year before. On the flip side, it has US$4.52m in cash leading to net debt of about US$14.5m.
How Strong Is VivoPower International’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that VivoPower International had liabilities of US$20.8m due within 12 months and liabilities of US$20.6m due beyond that. Offsetting this, it had US$4.52m in cash and US$9.77m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$27.1m.
This deficit casts a shadow over the US$17.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, VivoPower International would likely require a major re-capitalisation if it had to pay its creditors today. There’s no doubt that we learn most about debt from the balance sheet. But it is VivoPower International’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year VivoPower International managed to grow its revenue by 16%, to US$39m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Importantly, VivoPower International had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost a very considerable US$2.8m at the EBIT level. When we look at that alongside the significant liabilities, we’re not particularly confident about the company. We’d want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through US$2.2m in negative free cash flow over the last year. That means it’s on the risky side of things. For riskier companies like VivoPower International I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
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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