Is Wynnstay Group (LON:WYN) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Wynnstay Group Plc (LON:WYN) 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 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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Wynnstay Group

How Much Debt Does Wynnstay Group Carry?

The image below, which you can click on for greater detail, shows that Wynnstay Group had debt of UK£1.57m at the end of October 2020, a reduction from UK£3.04m over a year. However, its balance sheet shows it holds UK£20.0m in cash, so it actually has UK£18.4m net cash.

How Strong Is Wynnstay Group's Balance Sheet?

We can see from the most recent balance sheet that Wynnstay Group had liabilities of UK£58.2m falling due within a year, and liabilities of UK£6.93m due beyond that. Offsetting this, it had UK£20.0m in cash and UK£59.6m in receivables that were due within 12 months. So it can boast UK£14.5m more liquid assets than total liabilities.

This surplus suggests that Wynnstay Group is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Wynnstay Group has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Wynnstay Group has increased its EBIT by 4.3% over twelve months, which should ease any concerns about debt repayment. 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 Wynnstay 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Wynnstay Group 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. Happily for any shareholders, Wynnstay Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Wynnstay Group has net cash of UK£18.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of UK£18m, being 107% of its EBIT. So is Wynnstay Group's debt a risk? It doesn't seem so to us. Given Wynnstay Group has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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