Is WEG (BVMF:WEGE3) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies WEG S.A. (BVMF:WEGE3) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for WEG

What Is WEG's Debt?

The image below, which you can click on for greater detail, shows that WEG had debt of R$1.75b at the end of March 2021, a reduction from R$2.46b over a year. However, its balance sheet shows it holds R$3.87b in cash, so it actually has R$2.12b net cash.

A Look At WEG's Liabilities

Zooming in on the latest balance sheet data, we can see that WEG had liabilities of R$6.49b due within 12 months and liabilities of R$2.30b due beyond that. On the other hand, it had cash of R$3.87b and R$4.35b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$563.8m.

This state of affairs indicates that WEG's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the R$146.4b 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 60% over the last twelve months, and that growth will make it easier to handle its debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. WEG 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. During the last three years, WEG generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd 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 WEG has R$2.12b in net cash. And it impressed us with free cash flow of R$3.2b, being 82% of its EBIT. So we don't think WEG's use of debt is risky. 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.

When trading stocks or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide 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 (at) simplywallst.com.