Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Vestum AB (publisher) (STO:VESTUM) uses debt in its business. But the more important question is: what risk does this debt create?

When is debt a problem?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

See our latest review for Vestum

What is Vestum’s debt?

The image below, which you can click on for more details, shows that in March 2022, Vestum had a debt of 2.65 billion kr, compared to 28.8 million kr in one year. However, as it has a cash reserve of 978.0 million kr, its net debt is lower at around 1.67 billion kr.

A Look at Vestum’s Responsibilities

Zooming in on the latest balance sheet data, we can see that Vestum had liabilities of 1.44 billion kr due within 12 months and liabilities of 3.82 billion kr due beyond. As compensation for these obligations, it had liquid assets of 978.0 million kr as well as receivables valued at 929.0 million kr and payable within 12 months. It therefore has liabilities totaling kr 3.35 billion more than its cash and short-term receivables, combined.

That’s a mountain of leverage compared to its market capitalization of 5.53 billion kr. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Vestum shareholders face the double whammy of a high net debt to EBITDA ratio (6.1) and fairly low interest coverage, as EBIT is only 1.0 times operating expenses. ‘interests. This means that we would consider him to be heavily indebted. The silver lining is that Vestum grew its EBIT by 2,762% last year, which feeds like youthful idealism. If he can keep walking on this path, he will be able to get rid of his debt with relative ease. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Vestum 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, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past two years, Vestum has actually seen a cash outflow, overall. Debt is much riskier for companies with unreliable free cash flow, so shareholders must hope that past spending will produce free cash flow in the future.

Our point of view

To be frank, Vestum’s net debt to EBITDA ratio and history of covering its interest expense with its EBIT makes us rather uncomfortable with its debt levels. But at least it’s decent enough to increase its EBIT; it’s encouraging. Looking at the balance sheet and taking all of these factors into account, we think the debt makes Vestum stock a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on less debt. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, Vestum has 2 warning signs (and 1 that shouldn’t be ignored) that we think you should know about.

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.

Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.