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 risk.” It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies Valhi, Inc. (NYSE: VHI) uses debt. But does this debt worry shareholders?
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. 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 consider both liquidity and debt levels.
See our latest analysis for Valhi
How many debts does Valhi have?
As you can see below, Valhi had $ 765.5 million in debt, as of March 2021, which is roughly the same as the year before. You can click on the graph for more details. However, he also had $ 548.4 million in cash, so his net debt is $ 217.1 million.
Is Valhi’s track record healthy?
According to the latest published balance sheet, Valhi had debt of US $ 311.5 million due within 12 months and debt of US $ 1.53 billion due beyond 12 months. On the other hand, it had US $ 548.4 million in cash and US $ 362.8 million in receivables due within one year. It therefore has a liability totaling US $ 928.0 million more than its combined cash and short-term receivables.
Given that this deficit is actually greater than the company’s market cap of $ 657.9 million, we think shareholders should really watch Valhi’s debt levels, like a parent watching their child go crazy. cycling for the first time. In the event that the company were to clean up its balance sheet quickly, it seems likely that shareholders would suffer significant dilution.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Looking at his net debt over EBITDA of 1.1 and interest coverage of 4.2 times, it seems to us that Valhi is probably using the debt in a fairly reasonable way. We therefore recommend that you keep a close eye on the impact of financing costs on the business. It is important to note that Valhi’s EBIT was essentially stable over the past twelve months. We would rather see some growth in earnings, as it always helps reduce debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is Valhi’s results that will influence the balance sheet in the future. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Valhi has generated strong free cash flow equivalent to 64% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
We would go so far as to say that Valhi’s total liability level was disappointing. But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Once we consider all of the above factors together it seems like Valhi’s debt makes him a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 3 warning signs for Valhi of which you should be aware.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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This Simply Wall St article is general in nature. 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.
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