These 4 Measures Indicate That Wacker Chemie (ETR:WCH) 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.' 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. Importantly, Wacker Chemie AG (ETR:WCH) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 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 Wacker Chemie

What Is Wacker Chemie's Debt?

The chart below, which you can click on for greater detail, shows that Wacker Chemie had €1.28b in debt in December 2021; about the same as the year before. But it also has €1.67b in cash to offset that, meaning it has €382.2m net cash.

How Strong Is Wacker Chemie's Balance Sheet?

According to the last reported balance sheet, Wacker Chemie had liabilities of €1.71b due within 12 months, and liabilities of €3.32b due beyond 12 months. Offsetting this, it had €1.67b in cash and €966.3m in receivables that were due within 12 months. So its liabilities total €2.40b 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 €7.75b, 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!

Even more impressive was the fact that Wacker Chemie grew its EBIT by 303% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Wacker Chemie 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, Wacker Chemie actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While Wacker Chemie does have more liabilities than liquid assets, it also has net cash of €382.2m. And it impressed us with free cash flow of €743m, being 120% of its EBIT. So we don't think Wacker Chemie's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Wacker Chemie (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.