Washington H. Soul Pattinson (ASX:SOL) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Washington H. Soul Pattinson and Company Limited (ASX:SOL) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Washington H. Soul Pattinson

What Is Washington H. Soul Pattinson's Debt?

The image below, which you can click on for greater detail, shows that Washington H. Soul Pattinson had debt of AU$669.9m at the end of January 2022, a reduction from AU$864.3m over a year. However, it does have AU$1.08b in cash offsetting this, leading to net cash of AU$410.1m.

How Strong Is Washington H. Soul Pattinson's Balance Sheet?

We can see from the most recent balance sheet that Washington H. Soul Pattinson had liabilities of AU$531.2m falling due within a year, and liabilities of AU$1.37b due beyond that. On the other hand, it had cash of AU$1.08b and AU$402.8m worth of receivables due within a year. So its liabilities total AU$418.9m more than the combination of its cash and short-term receivables.

Of course, Washington H. Soul Pattinson has a market capitalization of AU$8.60b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Washington H. Soul Pattinson boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Washington H. Soul Pattinson turned things around in the last 12 months, delivering and EBIT of AU$978m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Washington H. Soul Pattinson 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. Washington H. Soul Pattinson may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Washington H. Soul Pattinson recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Washington H. Soul Pattinson has AU$410.1m in net cash. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in AU$795m. So is Washington H. Soul Pattinson's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Washington H. Soul Pattinson (1 is a bit concerning!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.