Is WEG (BVMF:WEGE3) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that WEG S.A. (BVMF:WEGE3) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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$1.64b at the end of September 2021, a reduction from R$1.97b over a year. But it also has R$2.94b in cash to offset that, meaning it has R$1.30b net cash.

How Healthy Is WEG's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that WEG had liabilities of R$7.53b due within 12 months and liabilities of R$1.83b due beyond that. Offsetting this, it had R$2.94b in cash and R$5.24b in receivables that were due within 12 months. So it has liabilities totalling R$1.18b more than its cash and near-term receivables, combined.

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$148.7b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, WEG boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, WEG grew its EBIT by 46% over the last twelve months, and that growth will make it easier to handle its debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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

We could understand if investors are concerned about WEG's liabilities, but we can be reassured by the fact it has has net cash of R$1.30b. And we liked the look of last year's 46% year-on-year EBIT growth. So is WEG's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of WEG's earnings per share history for free.

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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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.