Is WEG (BVMF:WEGE3) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 WEG S.A. (BVMF:WEGE3) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for WEG

How Much Debt Does WEG Carry?

The image below, which you can click on for greater detail, shows that at March 2023 WEG had debt of R$3.44b, up from R$3.08b in one year. However, it does have R$5.66b in cash offsetting this, leading to net cash of R$2.22b.

How Healthy Is WEG's Balance Sheet?

We can see from the most recent balance sheet that WEG had liabilities of R$11.1b falling due within a year, and liabilities of R$2.52b due beyond that. On the other hand, it had cash of R$5.66b and R$6.23b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$1.74b.

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$171.3b 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.

Also positive, WEG grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. 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 WEG 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. In the last three years, WEG's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that WEG has R$2.22b in net cash. And it impressed us with its EBIT growth of 27% over the last year. So is WEG's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in WEG, you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.