Warren Buffett said: “Volatility is far from synonymous with risk. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Watkin Jones Plc (LON:WJG) has debt on its balance sheet. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Watkin Jones
What is Watkin Jones’ net debt?
As you can see below, Watkin Jones was £12.0m in debt as of September 2021, up from £39.7m the previous year. But on the other hand, he also has £136.4m in cash, resulting in a net cash position of £124.5m.
A look at Watkin Jones’ responsibilities
Zooming in on the latest balance sheet data, we can see that Watkin Jones had liabilities of £109.5m due within 12 months and liabilities of £136.3m due beyond. As compensation for these obligations, it had cash of £136.4 million as well as receivables valued at £30.9 million maturing within 12 months. Thus, its liabilities total £78.5 million more than the combination of its cash and short-term receivables.
Given that publicly traded Watkin Jones shares are worth a total of £582.4 million, it seems unlikely that this level of liabilities will pose a major threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate. While he has liabilities to note, Watkin Jones also has more cash than debt, so we’re pretty confident he can manage his debt safely.
And we also warmly note that Watkin Jones increased its EBIT by 10% last year, making its leverage more manageable. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Watkin Jones’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a company can only repay its debts with cold hard cash, not with book profits. Although Watkin Jones has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how fast it’s building ( or erodes) this treasury. balance. Over the past three years, Watkin Jones has produced strong free cash flow equivalent to 74% of its EBIT, which is what we expected. This cold hard cash allows him to reduce his debt whenever he wants.
Although Watkin Jones has more liabilities than liquid assets, it also has a net cash position of £124.5m. And it impressed us with free cash flow of £61m, or 74% of its EBIT. So is Watkin Jones debt a risk? This does not seem to us to be the case. 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 outside of the balance sheet. Know that Watkin Jones shows 1 warning sign in our investment analysis you should know…
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.