Is Watches of Switzerland Group (LON:WOSG) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Watches of Switzerland Group plc (LON:WOSG) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Watches of Switzerland Group

What Is Watches of Switzerland Group's Net Debt?

The image below, which you can click on for greater detail, shows that Watches of Switzerland Group had debt of UK£68.0m at the end of October 2023, a reduction from UK£136.2m over a year. But on the other hand it also has UK£86.1m in cash, leading to a UK£18.1m net cash position.

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

We can see from the most recent balance sheet that Watches of Switzerland Group had liabilities of UK£302.4m falling due within a year, and liabilities of UK£488.2m due beyond that. Offsetting this, it had UK£86.1m in cash and UK£24.4m in receivables that were due within 12 months. So it has liabilities totalling UK£680.1m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of UK£943.4m, so it does suggest shareholders should keep an eye on Watches of Switzerland Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Watches of Switzerland Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Watches of Switzerland Group has increased its EBIT by 2.6% over twelve months, which should ease any concerns about debt repayment. 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 Watches of Switzerland Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Watches of Switzerland Group 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 three years, Watches of Switzerland Group produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Watches of Switzerland Group does have more liabilities than liquid assets, it also has net cash of UK£18.1m. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in UK£122m. So we are not troubled with Watches of Switzerland Group's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Watches of Switzerland Group .

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.