Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Viva Leisure Limited (ASX:VVA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Viva Leisure

What Is Viva Leisure's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Viva Leisure had debt of AU$7.62m, up from AU$1.30m in one year. But on the other hand it also has AU$35.3m in cash, leading to a AU$27.7m net cash position. debt-equity-history-analysis

How Strong Is Viva Leisure's Balance Sheet?

We can see from the most recent balance sheet that Viva Leisure had liabilities of AU$36.2m falling due within a year, and liabilities of AU$237.9m due beyond that. On the other hand, it had cash of AU$35.3m and AU$2.41m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$236.4m.

When you consider that this deficiency exceeds the company's AU$188.5m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Viva Leisure boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Viva Leisure's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this freereport showing analyst profit forecasts.



In the last year Viva Leisure wasn't profitable at an EBIT level, but managed to grow its revenue by 33%, to AU$54m. With any luck the company will be able to grow its way to profitability.

So How Risky Is Viva Leisure?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Viva Leisure had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through AU$18m of cash and made a loss of AU$11m. Given it only has net cash of AU$27.7m, the company may need to raise more capital if it doesn't reach break-even soon. With very solid revenue growth in the last year, Viva Leisure may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that  Viva Leisure is showing  2 warning signs in our investment analysis, you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt100% free, right now.

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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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