Some say that volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that “volatility is nowhere near synonymous with risk.” When we think about how risky a business is, we always like to look at the use of debt, as over-indebtedness can lead to ruin. We make a note of that Arbonia AG (VTX: ARBN) has debts on its balance sheet. But the more important question is, what is the risk this debt poses?
When is debt a problem?
Debt and other liabilities become risky for a company when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction,” in which failed companies are mercilessly liquidated by their bankers. While this isn’t too common, we often see indebted companies permanently diluting shareholders by forcing lenders to raise capital at a distressed price. However, in replacing the dilution, debt can be an extremely good tool for companies that need capital to invest in high-yielding growth. When examining debt, the first thing we do is look at both cash and debt together.
What is Arbonia’s debt?
The picture below, which you can click for more details, shows that at the end of December 2020 Arbonia had CHF 140.2 million in debt, which corresponds to a reduction of CHF 176.5 million over one year. However, since it has a cash reserve of CHF 52.1 million, the net debt is lower at around CHF 88.1 million.
A look at Arbonia’s liabilities
If we zoom in on the latest balance sheet data, we can see that Arbonia had liabilities of CHF 321.3 million within 12 months and liabilities of CHF 300.6 million beyond. To offset these obligations, it had cash and cash equivalents of CHF 52.1 million and receivables worth CHF 94.6 million that are due within 12 months. This means that liabilities are CHF 475.2 million more than the combination of cash and short-term receivables.
Arbonia has a market capitalization of CHF 1.14 billion, so it would very likely be able to raise cash to improve its balance sheet if needed. Nevertheless, it is worthwhile to examine the debt repayment carefully.
We use two main metrics to help us understand debt versus revenue. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), and the second is how often earnings before interest and taxes (EBIT) cover its interest expense (or interest coverage for short). . Therefore, we consider debt relative to earnings both with and without depreciation.
Arbonia has a low net debt to EBITDA ratio of just 0.73. And his EBIT easily covers 10.5 times the interest expense. So one could argue that it is no more threatened from its debts than an elephant is from a mouse. The good news is that Arbonia has increased its EBIT by 4.7% in twelve months, which should allay any concerns about debt settlement. Undoubtedly, we learn most about balance sheet debt. But ultimately, the company’s future profitability will determine whether Arbonia can strengthen its balance sheet over time. So if you are focused on the future, this is what you can check out here for free Analyst earnings forecast report.
After all, while the tax officer may worship book profits, lenders only accept cold cash. So we have to see clearly whether this EBIT leads to a corresponding free cash flow. Looking at the last three years, Arbonia even recorded an overall outflow of funds. Debt tends to be more expensive and almost always riskier in the hands of a negative free cash flow company. Shareholders should hope for an improvement.
The conversion of EBIT into Arbonia’s free cash flow was a real negative in this analysis, although the other factors we considered make this appear in a much better light. For example, his coverage of interests was refreshing. We think Arbonia’s debt makes it a bit risky after looking at the above data points together. Not all risk is bad as it can increase price returns if it pays off, but this debt risk should be kept in mind. Before most other metrics, we think it’s important to track how fast, if at all, earnings per share are growing. If you have come to this realization too, you are in luck because today you can Check out this interactive graph of Arbonia’s earnings per share for free.
After all that, if you’re more interested in a fast-growing company with a rock-solid balance sheet, then drop by our list of net cash growth stocks without delay.
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