David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, Vista Outdoor Inc. (NYSE: VSTO) is in debt. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
What is Vista Outdoor’s debt?
The image below, which you can click on for more details, shows that as of March 2022, Vista Outdoor had $666.1 million in debt, up from $495.6 million in one year. However, he also had $22.6 million in cash, so his net debt is $643.5 million.
How healthy is Vista Outdoor’s balance sheet?
We can see from the most recent balance sheet that Vista Outdoor had liabilities of $393.9 million due in one year and liabilities of $877.9 million beyond. In return, it had $22.6 million in cash and $400.3 million in receivables due within 12 months. Thus, its liabilities total $848.9 million more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not too bad since Vista Outdoor has a market capitalization of US$1.67 billion, so it could probably bolster its balance sheet by raising capital if needed. However, it is always worth taking a close look at its ability to repay debt.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Vista Outdoor has a low net debt to EBITDA ratio of just 0.89. And its EBIT covers its interest charges 25.7 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Even better, Vista Outdoor increased its EBIT by 137% last year, which is an impressive improvement. If sustained, this growth will make debt even more manageable in years to come. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Vista Outdoor can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Vista Outdoor has produced strong free cash flow equivalent to 67% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Vista Outdoor’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But truth be told, we think his total passive level undermines that impression a bit. Looking at the big picture, we think Vista Outdoor’s use of debt seems entirely reasonable and we don’t care. After all, reasonable leverage can increase return on equity. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. To do this, you need to find out about the 3 warning signs we spotted some with Vista Outdoor (including 1 that made us a little uncomfortable) .
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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