Does Wavestone (EPA:WAVE) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Wavestone SA (EPA:WAVE) makes use of debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Wavestone

What Is Wavestone's Debt?

As you can see below, Wavestone had €56.1m of debt at March 2021, down from €94.3m a year prior. However, its balance sheet shows it holds €88.0m in cash, so it actually has €31.9m net cash.

How Strong Is Wavestone's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wavestone had liabilities of €152.6m due within 12 months and liabilities of €87.8m due beyond that. Offsetting this, it had €88.0m in cash and €142.6m in receivables that were due within 12 months. So it has liabilities totalling €9.76m more than its cash and near-term receivables, combined.

Having regard to Wavestone's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the €853.4m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Wavestone boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Wavestone saw its EBIT decline by 4.7% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Wavestone'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 company can only pay off debt with cold hard cash, not accounting profits. While Wavestone 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. During the last three years, Wavestone generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

We could understand if investors are concerned about Wavestone's liabilities, but we can be reassured by the fact it has has net cash of €31.9m. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in €70m. So we don't think Wavestone'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. We've identified 1 warning sign with Wavestone , and understanding them should be part of your investment process.

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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