Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Walker Greenbank PLC (LON:WGB) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Walker Greenbank's Debt?
The image below, which you can click on for greater detail, shows that Walker Greenbank had debt of UK£1.54m at the end of July 2019, a reduction from UK£5.18m over a year. However, it does have UK£2.46m in cash offsetting this, leading to net cash of UK£922.0k.
How Healthy Is Walker Greenbank's Balance Sheet?
We can see from the most recent balance sheet that Walker Greenbank had liabilities of UK£26.5m falling due within a year, and liabilities of UK£12.8m due beyond that. Offsetting this, it had UK£2.46m in cash and UK£21.1m in receivables that were due within 12 months. So its liabilities total UK£15.7m more than the combination of its cash and short-term receivables.
Walker Greenbank has a market capitalization of UK£29.1m, 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. While it does have liabilities worth noting, Walker Greenbank also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Walker Greenbank's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Walker Greenbank'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Walker Greenbank may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Walker Greenbank produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While Walker Greenbank does have more liabilities than liquid assets, it also has net cash of UK£922.0k. So we don't have any problem with Walker Greenbank's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 5 warning signs for Walker Greenbank that you should be aware of before investing here.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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