The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ 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. As with many other companies Welbilt, Inc. (NYSE:WBT) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Welbilt
What Is Welbilt’s Net Debt?
As you can see below, Welbilt had US$1.45b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had US$122.9m in cash, and so its net debt is US$1.32b.
A Look At Welbilt’s Liabilities
Zooming in on the latest balance sheet data, we can see that Welbilt had liabilities of US$288.6m due within 12 months and liabilities of US$1.63b due beyond that. On the other hand, it had cash of US$122.9m and US$210.9m worth of receivables due within a year. So its liabilities total US$1.58b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of US$1.95b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Weak interest cover of 1.3 times and a disturbingly high net debt to EBITDA ratio of 7.7 hit our confidence in Welbilt like a one-two punch to the gut. This means we’d consider it to have a heavy debt load. Worse, Welbilt’s EBIT was down 50% over the last year. If earnings keep going like that over the long term, it has a snowball’s chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Welbilt can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Welbilt 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.
To be frank both Welbilt’s conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. After considering the datapoints discussed, we think Welbilt has too much debt. That sort of riskiness is ok for some, but it certainly doesn’t float our boat. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we’ve spotted 2 warning signs for Welbilt (of which 1 is concerning!) you should know about.
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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