These 4 Measures Indicate That West Fraser Timber (TSE:WFG) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies West Fraser Timber Co. Ltd. (TSE:WFG) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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.

See our latest analysis for West Fraser Timber

How Much Debt Does West Fraser Timber Carry?

As you can see below, West Fraser Timber had US$499.0m of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$2.11b in cash, so it actually has US$1.61b net cash.

How Strong Is West Fraser Timber's Balance Sheet?

The latest balance sheet data shows that West Fraser Timber had liabilities of US$1.28b due within a year, and liabilities of US$1.51b falling due after that. Offsetting this, it had US$2.11b in cash and US$556.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$129.0m.

This state of affairs indicates that West Fraser Timber's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$9.69b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, West Fraser Timber also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that West Fraser Timber grew its EBIT by 876% over twelve months. That boost will make it even easier to pay down debt going forward. 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 West Fraser Timber 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. West Fraser Timber 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. Over the last two years, West Fraser Timber recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually 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 West Fraser Timber has US$1.61b in net cash. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in US$3.3b. So is West Fraser Timber's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for West Fraser Timber you should be aware of, and 2 of them can't be ignored.

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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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.