WEG (BVMF:WEGE3) Has A Rock Solid Balance Sheet

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. Importantly, WEG S.A. (BVMF:WEGE3) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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.

See our latest analysis for WEG

What Is WEG's Net Debt?

You can click the graphic below for the historical numbers, but it shows that WEG had R$1.97b of debt in September 2020, down from R$2.97b, one year before. But it also has R$3.60b in cash to offset that, meaning it has R$1.63b net cash.

A Look At WEG's Liabilities

The latest balance sheet data shows that WEG had liabilities of R$4.92b due within a year, and liabilities of R$2.72b falling due after that. Offsetting this, it had R$3.60b in cash and R$3.92b in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

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$171.1b 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.

In addition to that, we're happy to report that WEG has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. 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.

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 last three years, WEG recorded free cash flow worth a fulsome 80% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that WEG has R$1.63b in net cash. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in R$2.8b. 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.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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