Stock Analysis

WEG (BVMF:WEGE3) Seems To Use Debt Rather Sparingly

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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that WEG S.A. (BVMF:WEGE3) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

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How Much Debt Does WEG Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 WEG had R$3.84b of debt, an increase on R$1.64b, over one year. However, its balance sheet shows it holds R$4.14b in cash, so it actually has R$307.9m net cash.

BOVESPA:WEGE3 Debt to Equity History January 28th 2023

A Look At WEG's Liabilities

According to the last reported balance sheet, WEG had liabilities of R$10.8b due within 12 months, and liabilities of R$2.62b due beyond 12 months. On the other hand, it had cash of R$4.14b and R$6.60b worth of receivables due within a year. So its liabilities total R$2.66b more than the combination of its cash and short-term receivables.

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$159.1b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, WEG boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that WEG has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. 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 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. Looking at the most recent three years, WEG recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying 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$307.9m in net cash. And we liked the look of last year's 35% year-on-year EBIT growth. So is WEG's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with WEG , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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