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 should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Watkin Jones

How Much Debt Does Watkin Jones Carry?

You can click the graphic below for the historical numbers, but it shows that Watkin Jones had UK£17.9m of debt in March 2022, down from UK£57.0m, one year before. However, its balance sheet shows it holds UK£44.7m in cash, so it actually has UK£26.8m net cash.

How Healthy Is Watkin Jones' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Watkin Jones had liabilities of UK£89.2m due within 12 months and liabilities of UK£167.8m due beyond that. Offsetting these obligations, it had cash of UK£44.7m as well as receivables valued at UK£93.2m due within 12 months. So its liabilities total UK£119.2m more than the combination of its cash and short-term receivables.

Watkin Jones has a market capitalization of UK£524.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Watkin Jones boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Watkin Jones has seen its EBIT plunge 17% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Watkin Jones 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. Over the most recent three years, Watkin Jones recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Watkin Jones does have more liabilities than liquid assets, it also has net cash of UK£26.8m. 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. We've identified 3 warning signs with Watkin Jones , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.