Howard Marks put 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 every investor practice that I know is worried “. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies Water company (NYSE: WAT) uses debt. But the most important question is: what risk does this debt create?
When is debt a problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Consult our latest analysis for waters
What is Waters’ debt?
As you can see below, Waters had $ 1.63 billion in debt in July 2021, up from $ 1.70 billion the year before. However, it has US $ 663.6 million in cash offsetting this, which leads to net debt of around US $ 962.2 million.
A look at Waters’ liabilities
The latest balance sheet data shows Waters had liabilities of US $ 681.0 million due within one year and liabilities of US $ 2.15 billion due after that. In return, he had $ 663.6 million in cash and $ 543.1 million in receivables due within 12 months. Its liabilities therefore total US $ 1.63 billion more than the combination of its cash and short-term receivables.
Of course, Waters has a titanic market cap of $ 24.5 billion, so those liabilities are likely manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Waters’ net debt is only 1.0 times its EBITDA. And its EBIT covers its interest costs 28.5 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Also positive, Waters has increased its EBIT by 28% over the past year, which should make it easier to pay down debt going forward. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Waters can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a company cannot pay its debts with paper profits; he needs hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Waters has generated strong free cash flow equivalent to 76% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
Waters’ interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news doesn’t end there, because its EBIT growth rate also supports this impression! Given this array of factors, it seems to us that Waters is being fairly conservative with its debt, and the risks appear to be well managed. We are therefore not worried about the use of a small leverage on the balance sheet. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. We have identified 2 warning signs with Waters and understanding them should be part of your investment process.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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