Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Wacker Neuson SE (ETR:WAC) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Wacker Neuson's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Wacker Neuson had debt of €535.2m, up from €246.8m in one year. However, it does have €69.2m in cash offsetting this, leading to net debt of about €466.0m.
How Strong Is Wacker Neuson's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Wacker Neuson had liabilities of €543.7m due within 12 months and liabilities of €531.3m due beyond that. Offsetting these obligations, it had cash of €69.2m as well as receivables valued at €412.6m due within 12 months. So it has liabilities totalling €593.2m more than its cash and near-term receivables, combined.
Wacker Neuson has a market capitalization of €1.07b, 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.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Wacker Neuson's net debt to EBITDA ratio of about 2.4 suggests only moderate use of debt. And its commanding EBIT of 24.8 times its interest expense, implies the debt load is as light as a peacock feather. Wacker Neuson grew its EBIT by 6.5% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Wacker Neuson can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Wacker Neuson saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Wacker Neuson's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. When we consider all the factors discussed, it seems to us that Wacker Neuson is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. Given Wacker Neuson has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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