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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies. Over the Wire Holdings Limited (ASX:OTW) makes use of debt. But the real question is whether this debt is making the company risky.
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Over the Wire Holdings Carry?
As you can see below, Over the Wire Holdings had AU$12.4m of debt at December 2018, down from AU$15.0m a year prior. On the flip side, it has AU$8.43m in cash leading to net debt of about AU$3.95m.
A Look At Over the Wire Holdings’s Liabilities
The latest balance sheet data shows that Over the Wire Holdings had liabilities of AU$24.7m due within a year, and liabilities of AU$19.7m falling due after that. On the other hand, it had cash of AU$8.43m and AU$7.19m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$28.8m.
Since publicly traded Over the Wire Holdings shares are worth a total of AU$261.1m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Because it carries more debt than cash, we think it’s worth watching Over the Wire Holdings’s balance sheet over time.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Over the Wire Holdings has a low net debt to EBITDA ratio of only 0.27. And its EBIT easily covers its interest expense, being 19.6 times the size. So we’re pretty relaxed about its super-conservative use of debt. In addition to that, we’re happy to report that Over the Wire Holdings has boosted its EBIT by 62%, thus reducing the spectre of future debt repayments. 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 Over the Wire Holdings 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Over the Wire Holdings produced sturdy free cash flow equating to 72% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
The good news is that Over the Wire Holdings’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that’s just the beginning of the good news since its EBIT growth rate is also very heartening. Considering this range of factors, it seems to us that Over the Wire Holdings is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. We’d be very excited to see if Over the Wire Holdings insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.