Yahoo Finance Here's Why Arvida Group (NZSE:ARV) Has A Meaningful Debt Burden
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Arvida Group Limited (NZSE:ARV) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Arvida Group
How Much Debt Does Arvida Group Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Arvida Group had debt of NZ$193.1m, up from NZ$122.8m in one year. However, because it has a cash reserve of NZ$4.57m, its net debt is less, at about NZ$188.5m.
How Strong Is Arvida Group's Balance Sheet?
According to the last reported balance sheet, Arvida Group had liabilities of NZ$85.1m due within 12 months, and liabilities of NZ$664.8m due beyond 12 months. Offsetting these obligations, it had cash of NZ$4.57m as well as receivables valued at NZ$17.1m due within 12 months. So it has liabilities totalling NZ$728.3m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of NZ$732.2m, so it does suggest shareholders should keep an eye on Arvida Group's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With a net debt to EBITDA ratio of 8.4, it's fair to say Arvida Group does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 4.2 times, suggesting it can responsibly service its obligations. More concerning, Arvida Group saw its EBIT drop by 8.9% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Arvida Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Arvida Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our View
Neither Arvida Group's ability handle its debt, based on its EBITDA, nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. It's also worth noting that Arvida Group is in the Healthcare industry, which is often considered to be quite defensive. Taking the abovementioned factors together we do think Arvida Group's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. Given Arvida Group has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
