We Think WEG (BVMF:WEGE3) Can Manage Its Debt With Ease

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, WEG S.A. (BVMF:WEGE3) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for WEG

How Much Debt Does WEG Carry?

You can click the graphic below for the historical numbers, but it shows that WEG had R$1.69b of debt in December 2020, down from R$2.28b, one year before. However, it does have R$4.48b in cash offsetting this, leading to net cash of R$2.80b.

How Strong Is WEG's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that WEG had liabilities of R$5.88b due within 12 months and liabilities of R$2.12b due beyond that. On the other hand, it had cash of R$4.48b and R$3.76b worth of receivables due within a year. So it can boast R$243.9m more liquid assets than total liabilities.

Having regard to WEG's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the R$181.9b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that WEG has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly, WEG grew its EBIT by 53% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine WEG's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. During the last three years, WEG generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that WEG has net cash of R$2.80b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of R$3.4b, being 91% 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.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.
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