Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, Wilson ASA (OB:WILS) is in debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
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. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. 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 and debt together.
See our latest analysis for Wilson
What is Wilson’s debt?
You can click on the chart below for historical figures, but it shows Wilson had €114.9m in debt in March 2022, up from €130.5m a year earlier. However, he has €39.2m in cash which makes up for this, resulting in a net debt of around €75.8m.
A look at Wilson’s responsibilities
We can see from the most recent balance sheet that Wilson had liabilities of 82.3 million euros maturing in one year and liabilities of 149.5 million euros due beyond. In return for these bonds, it had cash of €39.2 million as well as receivables worth €33.4 million maturing in less than 12 months. Its liabilities therefore total €159.2 million more than the combination of its cash and short-term receivables.
Wilson has a market capitalization of 302.7 million euros, so he could very likely raise funds to improve his balance sheet, if the need arose. But it is clear that it must be carefully examined whether he can manage his debt without dilution.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Wilson has a low net debt to EBITDA ratio of just 0.77. And its EBIT covers its interest charges 14.8 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Even more impressive is the fact that Wilson increased its EBIT by 221% year-over-year. This boost will make it even easier to pay off debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Wilson will need income to repay that debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Fortunately for all shareholders, Wilson has actually produced more free cash flow than EBIT over the past three years. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
The good news is that Wilson’s demonstrated ability to cover his interest costs with his EBIT thrills us like a fluffy pup does a toddler. But truth be told, we think his total passive level undermines that impression a bit. Zooming out, Wilson seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example – Wilson has 2 warning signs we think you should know.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.
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