We Think Weir Group (LON:WEIR) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that The Weir Group PLC (LON:WEIR) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Weir Group

What Is Weir Group's Debt?

As you can see below, Weir Group had UK£1.35b of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has UK£626.9m in cash leading to net debt of about UK£723.8m.

How Healthy Is Weir Group's Balance Sheet?

According to the last reported balance sheet, Weir Group had liabilities of UK£867.9m due within 12 months, and liabilities of UK£1.33b due beyond 12 months. Offsetting these obligations, it had cash of UK£626.9m as well as receivables valued at UK£555.3m due within 12 months. So its liabilities total UK£1.02b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Weir Group is worth UK£4.68b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a debt to EBITDA ratio of 1.7, Weir Group uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 9.4 times its interest expenses harmonizes with that theme. We note that Weir Group grew its EBIT by 24% in the last year, and that should make it 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 Weir Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Weir Group produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Weir Group's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its interest cover also supports that impression! Taking all this data into account, it seems to us that Weir Group takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Weir Group that you should be aware of.

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.