Is Wall Financial (TSE:WFC) A Risky Investment?

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.' 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. We note that Wall Financial Corporation (TSE:WFC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for Wall Financial

How Much Debt Does Wall Financial Carry?

As you can see below, Wall Financial had CA$581.8m of debt at October 2021, down from CA$634.6m a year prior. On the flip side, it has CA$25.4m in cash leading to net debt of about CA$556.3m.

A Look At Wall Financial's Liabilities

We can see from the most recent balance sheet that Wall Financial had liabilities of CA$340.8m falling due within a year, and liabilities of CA$278.9m due beyond that. Offsetting these obligations, it had cash of CA$25.4m as well as receivables valued at CA$16.6m due within 12 months. So it has liabilities totalling CA$577.7m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's CA$536.8m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With a net debt to EBITDA ratio of 8.8, it's fair to say Wall Financial does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 4.6 times, suggesting it can responsibly service its obligations. Pleasingly, Wall Financial is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 351% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Wall Financial's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Wall Financial actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Based on what we've seen Wall Financial is not finding it easy, given its net debt to EBITDA, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Wall Financial's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Wall Financial , 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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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.