Here's Why Naked Wines (LON:WINE) Is Weighed Down By Its Debt Load

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. We can see that Naked Wines plc (LON:WINE) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Naked Wines

How Much Debt Does Naked Wines Carry?

You can click the graphic below for the historical numbers, but it shows that as of October 2023 Naked Wines had UK£31.0m of debt, an increase on UK£18.8m, over one year. However, its balance sheet shows it holds UK£33.8m in cash, so it actually has UK£2.81m net cash.

A Look At Naked Wines' Liabilities

According to the last reported balance sheet, Naked Wines had liabilities of UK£133.3m due within 12 months, and liabilities of UK£33.7m due beyond 12 months. Offsetting this, it had UK£33.8m in cash and UK£5.39m in receivables that were due within 12 months. So its liabilities total UK£127.8m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the UK£35.4m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Naked Wines would probably need a major re-capitalization if its creditors were to demand repayment. Given that Naked Wines has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

We also note that Naked Wines improved its EBIT from a last year's loss to a positive UK£8.4m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Naked Wines'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 Naked Wines 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 year, Naked Wines burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

Although Naked Wines's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£2.81m. Unfortunately, though, both its struggle level of total liabilities and its conversion of EBIT to free cash flow leave us concerned about Naked Wines So even though it has net cash, we do think the business has some risks worth watching. 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. To that end, you should learn about the 2 warning signs we've spotted with Naked Wines (including 1 which makes us a bit uncomfortable) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.