David Iben put it well when he said, “Volatility is not a risk we care about. What we care about is preventing permanent loss of capital.’ So it may be obvious that you need to factor in debt when you consider how risky a particular stock is, as too much debt can sink a company. important, Weizmann Limited (NSE:WEIZMANIND) does bear debt. But should shareholders be concerned about using debt?
Why does debt involve risks?
Debt helps a company until the company struggles to pay it off, either with new capital or free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is a company having to issue shares at spot prices, permanently diluting shareholders, just to bolster its balance sheet. However, by replacing dilution, debt can be an extremely good tool for companies that need capital to invest in high-yield growth. The first step in considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Weizmann
What is Weizmann’s fault?
As you can see below, Weizmann had debt of 158.6 million in March 2021, compared to 189.3 million years earlier. However, it also had 12.4 million in cash, so the net debt is 146.2 million.
A Look at Weizmann’s Obligations
According to the last reported balance sheet, Weizmann had liabilities of 411.6 million with a maturity of 12 months and liabilities of 20.5 million with a maturity of more than 12 months. This was offset by ₹ 12.4 million in cash and ₹ 182.6 million in receivables to be paid within 12 months. Thus, its liabilities total 237.1 million more than the combination of its cash and receivables.
This shortfall is not so bad, as Weizmann is worth $1.10 billion and so could probably raise enough capital to bolster its balance sheet if needed. But we definitely want to keep our eyes peeled for evidence that his debt carries too much risk.
To upgrade a company’s debt relative to revenue, we calculate net debt divided by revenue before interest, taxes, depreciation, and amortization (EBITDA) and revenue before interest and tax (EBIT) divided by interest expense (are 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).
While Weizmann’s low debt-to-EBITDA ratio of 1.3 suggests only modest use of debt, the fact that last year’s EBIT only covered interest charges 6.4 times gives us pause. We therefore recommend keeping a close eye on the impact of financing costs on the business. Another good sign is that Weizmann has been able to increase its EBIT by 23% in twelve months, making it easier to pay off debt. There is no doubt that we learn the most about debt from the balance sheet. But you can’t see debt completely isolated; because Weizmann needs income to pay off that debt. So when considering debt, it’s definitely worth looking at earnings performance. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it’s worth checking how much of that EBIT is backed by free cash flow. In the past three years, Weizmann produced even more free cash flow than EBIT. That kind of strong cash conversion gets us just as excited as the audience when the beat sinks in at a Daft Punk concert.
Fortunately, Weizmann’s impressive conversion of EBIT to free cash flow implies that it has the upper hand over its debt. And that’s just the beginning of the good news, as EBIT growth is also very encouraging. Zooming out, Weizmann seems reasonable in dealing with debt; and that gets the wink from us. While debt carries risks, when used wisely, it can also provide a higher return on equity. The balance sheet is clearly the area to focus on when analyzing debt. But in the end, any business can contain risks that exist off-balance sheet. To this end, you must be aware of the 2 warning signs we spotted with Weizmann .
At the end of the day, it’s often better to focus on companies that are free of net debt. You can access our special list of such companies (all with a track record of earnings growth). It is free.
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