Is WEG (BVMF:WEGE3) A Risky Investment?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that WEG S.A. (BVMF:WEGE3) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for WEG

How Much Debt Does WEG Carry?

The image below, which you can click on for greater detail, shows that WEG had debt of R$2.12b at the end of June 2020, a reduction from R$2.91b over a year. But it also has R$2.85b in cash to offset that, meaning it has R$725.5m net cash.

How Healthy Is WEG's Balance Sheet?

According to the last reported balance sheet, WEG had liabilities of R$4.69b due within 12 months, and liabilities of R$2.69b due beyond 12 months. On the other hand, it had cash of R$2.85b and R$3.82b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$709.3m.

Having regard to WEG's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the R$143.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, WEG also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that WEG has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if WEG 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 company can only pay off debt with cold hard cash, not accounting profits. While WEG has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, WEG recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that WEG has R$725.5m in net cash. And it impressed us with its EBIT growth of 35% over the last year. So we don't think WEG's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for WEG you should be aware of.

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.

If you decide to trade WEG, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.