Some say that volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett once said that “volatility is far from synonymous with risk.” When we think about how risky a business is, we always like to look at the use of debt, as over-indebtedness can lead to ruin. important, Welbilt, Inc. (NYSE:WBT) does bear debt. But should shareholders be concerned about using debt?
What risk does debt entail?
Debt helps a company until the company struggles to pay it off, either with new capital or free cash flow. An essential part of capitalism is the process of ‘creative destruction’, in which failed companies are mercilessly liquidated by their bankers. However, a more common (but still expensive) situation is that a company has to dilute shareholders at a cheap share price in order to get its debt under control. That said, the most common situation is for a company to manage its debt fairly well — and for its own benefit. The first thing to do when considering how much debt a company uses is to look at its cash and debt together.
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What is Welbilt’s Net Debt?
As you can see below, Welbilt was in debt of $1.44 billion in March 2021, down from $1.51 billion a year earlier. However, it also had $140.3 million in cash, so its net debt is $1.30 billion.
How healthy is Welbilt’s balance sheet?
If we zoom in on the most recent balance sheet data, we can see that Welbilt had liabilities of $268.6 million due within 12 months and $1.62 billion thereafter. To offset these obligations, the company had USD 140.3 million in cash and USD 201.6 million receivables to be paid within 12 months. So his liabilities total US$1.55 billion more than the combination of his cash and receivables.
While this may seem like a lot, it’s not such a big deal, as Welbilt has a market cap of US$3.54 billion, so could probably strengthen its balance sheet by raising capital if needed. But we definitely want to keep our eyes peeled for evidence that his debt carries too much risk.
We measure a company’s indebtedness relative to its earning capital by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and by calculating how easily its earnings before interest and taxes (EBIT) offset interest. cover costs (interest cover). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with the interest coverage ratio).
Welbilt shareholders face the double blow of a high net debt-to-EBITDA ratio (6.9) and fairly weak interest coverage, as EBIT is only 1.6 times the cost of interest. The debt burden here is considerable. Even worse, Welbilt saw its EBIT tank 41% over the past 12 months. If long-term earnings continue to rise like this, there’s a snowball opportunity in hell to pay off that debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is primarily future income that will determine Welbilt’s ability to maintain a healthy balance sheet going forward. So if you want to see what the pros think, you might find this free analyst earnings forecast report be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we need to see clearly whether that EBIT leads to a corresponding free cash flow. Over the past three years, Welbilt has seen significant negative free cash flow overall. While that may be the result of spending on growth, it does make debt much more risky.
At first glance, Welbilt’s conversion from EBIT to free cash flow left us hesitant about inventory, and the EBIT growth rate was no more attractive than that one empty restaurant on the busiest night of the year. That said, the ability to handle its total obligations is not much of a concern. Taking all of the above factors into account, it seems that Welbilt has too much debt. That kind of risk is okay for some, but it certainly doesn’t keep our boat afloat. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside within the balance sheet – far from it. For example, Welbilt has: 4 warning signs (and 1 which is a bit unpleasant) we think you should know.
If you are the type of investor who prefers to buy stocks without debt, don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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This article from Simply Wall St is general in nature. It is not a recommendation to buy or sell stocks and does not take into account your objectives or your financial situation. We strive to provide you with long-term focused analysis powered by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or quality material. Simply Wall St has no position in said stocks.
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