Is Watches of Switzerland Group (LON:WOSG) A Risky Investment?

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 note that Watches of Switzerland Group plc (LON:WOSG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Watches of Switzerland Group

What Is Watches of Switzerland Group's Net Debt?

As you can see below, at the end of October 2022, Watches of Switzerland Group had UK£136.2m of debt, up from UK£118.3m a year ago. Click the image for more detail. However, it does have UK£111.6m in cash offsetting this, leading to net debt of about UK£24.6m.

How Strong Is Watches of Switzerland Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Watches of Switzerland Group had liabilities of UK£309.8m due within 12 months and liabilities of UK£481.7m due beyond that. Offsetting these obligations, it had cash of UK£111.6m as well as receivables valued at UK£21.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£658.8m.

While this might seem like a lot, it is not so bad since Watches of Switzerland Group has a market capitalization of UK£1.93b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Carrying virtually no net debt, Watches of Switzerland Group has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Watches of Switzerland Group has net debt of just 0.13 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.7 times, which is more than adequate. Another good sign is that Watches of Switzerland Group has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Watches of Switzerland 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Watches of Switzerland Group recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that Watches of Switzerland Group's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Looking at the bigger picture, we think Watches of Switzerland Group's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. We'd be very excited to see if Watches of Switzerland Group insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.