Here’s why V2 Retail (NSE: V2RETAIL) has a significant debt burden
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss. of capital “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Like many other companies V2 Retail Limited (NSE: V2RETAIL) uses debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first look at cash and debt levels, together.
See our latest analysis for V2 Retail
What is V2 Retail’s net debt?
The image below, which you can click for more details, shows that in September 2021 V2 Retail was in debt of 554.8 million yen, up from 156.0 million yen in a year. However, it has € 67.4 million in cash offsetting this, leading to net debt of around € 487.4 million.
A look at the responsibilities of V2 Retail
The latest balance sheet data shows that V2 Retail had liabilities of 2.50 billion yen due within one year, and liabilities of 3.05 billion yen due thereafter. In return, he had € 67.4 million in cash and € 55.7 million in receivables due within 12 months. It therefore has liabilities totaling 5.43 billion yen more than its cash and short-term receivables combined.
When you consider that this shortfall exceeds the company’s 5.38b market cap, you may well be inclined to take a close look at the balance sheet. In the event that the company were to clean up its balance sheet quickly, it seems likely that shareholders would suffer significant dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While V2 Retail has a very reasonable net debt to EBITDA ratio of 2.0, its interest coverage appears low at 0.091. The main reason is that it has such high depreciation and amortization. While companies often boast that these fees are not cash, most of these companies will therefore need an ongoing investment (which is not expensed). In any case, we can say that the company has a significant debt. Notably, V2 Retail recorded a loss in EBIT level last year, but improved it to reach a positive EBIT of 30 million euros in the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in isolation; since V2 Retail will need income to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore important to check to what extent its earnings before interest and taxes (EBIT) are converted into actual free cash flow. Fortunately for all shareholders, V2 Retail actually generated more free cash flow than EBIT over the past year. There is nothing better than cash flow to stay in the good graces of your lenders.
Our point of view
Neither V2 Retail’s ability to cover its interest charges with its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is that it looks like it can easily convert EBIT into free cash flow. Taking the aforementioned factors together, we believe that V2 Retail’s debt presents certain risks to the business. So while this leverage increases returns on equity, we wouldn’t really want to see it increase from here. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. Note that V2 Retail displays 3 warning signs in our investment analysis , and 1 of them is a bit rude …
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.