David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies The Weir PLC Group (LON:WEIR) uses debt. But does this debt worry shareholders?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
Discover our latest analysis for Weir Group
What is Weir Group’s debt?
The chart below, which you can click on for more details, shows that Weir Group had £1.23 billion in debt in December 2021; about the same as the previous year. However, he also had £564.4m in cash, so his net debt is £667.1m.
A look at the responsibilities of the Weir Group
According to the latest published balance sheet, Weir Group had liabilities of £1.06 billion due within 12 months and liabilities of £978.8 million due beyond 12 months. On the other hand, it had cash of £564.4 million and £492.2 million of receivables due within a year. Thus, its liabilities total £984.6 million more than the combination of its cash and short-term receivables.
Weir Group has a market capitalization of £3.64 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But it is clear that it must be carefully examined whether he can manage his debt without dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Weir Group’s net debt of 2.1x EBITDA suggests judicious use of debt. And the attractive interest coverage (EBIT of 7.0 times interest expense) certainly makes not do everything to dispel this impression. If Weir Group can continue to grow EBIT at last year’s rate of 13% over last year, then it will find its leverage easier to manage. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Weir Group’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Weir Group has recorded free cash flow of 63% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
The good news is that Weir Group’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And its EBIT growth rate is also good. Looking at all of the aforementioned factors together, it seems to us that Weir Group can manage its debt quite comfortably. On the plus side, this leverage can increase shareholder returns, but the potential downside is greater risk of loss, so it’s worth keeping an eye on the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. For example, we found 2 warning signs for Weir Group (1 is potentially serious!) which you should be aware of before investing here.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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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.