Is Wacker Chemie (ETR:WCH) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Wacker Chemie AG (ETR:WCH) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Wacker Chemie

How Much Debt Does Wacker Chemie Carry?

The chart below, which you can click on for greater detail, shows that Wacker Chemie had €1.29b in debt in December 2022; about the same as the year before. However, its balance sheet shows it holds €1.77b in cash, so it actually has €486.3m net cash.

How Healthy Is Wacker Chemie's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wacker Chemie had liabilities of €1.93b due within 12 months and liabilities of €2.44b due beyond that. Offsetting this, it had €1.77b in cash and €1.15b in receivables that were due within 12 months. So its liabilities total €1.45b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Wacker Chemie has a market capitalization of €6.95b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Wacker Chemie 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 Wacker Chemie has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Wacker Chemie's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Wacker Chemie 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. During the last three years, Wacker Chemie produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Wacker Chemie's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €486.3m. And it impressed us with its EBIT growth of 40% over the last year. So is Wacker Chemie's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Wacker Chemie (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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. 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.