June 24, 2024 [Simply Wall]- David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ 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, Koninklijke Vopak N.V. does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Koninklijke Vopak

How Much Debt Does Koninklijke Vopak Carry?

Koninklijke Vopak had €2.48b of debt in December 2023, down from €3.08b, one year before. However, it also had €197.0m in cash, and so its net debt is €2.29b.

How Healthy Is Koninklijke Vopak’s Balance Sheet?

The latest balance sheet data shows that Koninklijke Vopak had liabilities of €668.8m due within a year, and liabilities of €2.61b falling due after that. Offsetting these obligations, it had cash of €197.0m as well as receivables valued at €380.1m due within 12 months. So its liabilities total €2.70b more than the combination of its cash and short-term receivables.

Koninklijke Vopak has a market capitalization of €4.69b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Koninklijke Vopak has a debt to EBITDA ratio of 3.4 and its EBIT covered its interest expense 3.9 times. Taken together this implies that, while we wouldn’t want to see debt levels rise, we think it can handle its current leverage. The good news is that Koninklijke Vopak improved its EBIT by 3.0% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. 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 Koninklijke Vopak’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Koninklijke Vopak actually produced more free cash flow than EBIT. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.

Our View

When it comes to the balance sheet, the standout positive for Koninklijke Vopak was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren’t so encouraging. For instance it seems like it has to struggle a bit handle its debt, based on its EBITDA,. Looking at all this data makes us feel a little cautious about Koninklijke Vopak’s debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We’ve identified 2 warning signswith Koninklijke Vopak (at least 1 which is significant), and understanding them should be part of your investment process.