Watkin Jones (LON:WJG) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Watkin Jones Plc (LON:WJG) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Watkin Jones

What Is Watkin Jones's Debt?

As you can see below, Watkin Jones had UK£39.7m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has UK£134.9m in cash, leading to a UK£95.2m net cash position.

How Strong Is Watkin Jones' Balance Sheet?

According to the last reported balance sheet, Watkin Jones had liabilities of UK£120.4m due within 12 months, and liabilities of UK£171.7m due beyond 12 months. On the other hand, it had cash of UK£134.9m and UK£58.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£99.0m.

Since publicly traded Watkin Jones shares are worth a total of UK£562.0m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Watkin Jones boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Watkin Jones saw its EBIT drop by 7.7% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Watkin Jones'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Watkin Jones 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. Over the most recent three years, Watkin Jones recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although Watkin Jones'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£95.2m. And it impressed us with free cash flow of UK£38m, being 73% of its EBIT. So we don't have any problem with Watkin Jones's use of debt. 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. Case in point: We've spotted 4 warning signs for Watkin Jones you should be aware of.

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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