Is Vertu Motors (LON: VTU) a risky investment?

Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Above all, Vertu Motors plc (LON: VTU) is in debt. But does this debt worry shareholders?

When is debt dangerous?

Debt helps a business until the business struggles to repay it, either with new capital or with free 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. 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 think of a business’s use of debt, we first look at cash flow and debt together.

Check out our latest review for Vertu Motors

What is Vertu Motors’ net debt?

As you can see below, Vertu Motors was in debt of £ 56.5million in August 2021, up from £ 66.5million the year before. But on the other hand, he also has £ 113.5million in cash, which leads to a net cash position of £ 57.0million.

AIM: History of debt to equity of VTU December 4, 2021

How strong is Vertu Motors’ balance sheet?

We can see from the most recent balance sheet that Vertu Motors had a liability of £ 515.9million maturing within one year and a liability of £ 156.6million beyond. In return, he had £ 113.5 million in cash and £ 43.0 million in receivables due within 12 months. It therefore has liabilities totaling £ 515.9million more than its cash and short-term receivables combined.

This deficit casts a shadow over the £ 232.2million company like a towering colossus of mere mortals. We would therefore monitor its record closely, without a doubt. After all, Vertu Motors would likely need a major recapitalization if it were to pay its creditors today. Since Vertu Motors has more cash than debt, we’re pretty confident that it can handle its debt, despite having a lot of liabilities altogether.

Even more impressive was the fact that Vertu Motors increased its EBIT by 292% year over year. This boost will make it even easier to pay down debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Vertu Motors’ ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.

Finally, a business can only pay off its debts with hard cash, not with book profits. While Vertu Motors has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it’s building ( or erodes) this cash balance. Fortunately for all shareholders, Vertu Motors has actually generated more free cash flow than EBIT over the past three years. This kind of cash conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.

In summary

Although Vertu Motors’ balance sheet is not particularly strong, due to total liabilities it is clearly positive that it has a net cash position of £ 57.0million. And he impressed us with free cash flow of £ 59million, or 107% of his EBIT. So we have no problem with the use of debt by Vertu Motors. When analyzing debt levels, the balance sheet is the obvious place to start. But at the end of the day, every business can contain risks that exist off the balance sheet. Note that Vertu Motors displays 3 warning signs in our investment analysis , and 1 of them cannot be ignored …

If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.

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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 any stock 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 any of the stocks mentioned.

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