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.' 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 Ocean Wilsons Holdings Limited (LON:OCN) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Ocean Wilsons Holdings's Debt?
As you can see below, Ocean Wilsons Holdings had US$334.5m of debt, at June 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 US$364.4m in cash, leading to a US$29.9m net cash position.
How Strong Is Ocean Wilsons Holdings's Balance Sheet?
According to the last reported balance sheet, Ocean Wilsons Holdings had liabilities of US$124.9m due within 12 months, and liabilities of US$482.7m due beyond 12 months. Offsetting these obligations, it had cash of US$364.4m as well as receivables valued at US$66.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$176.3m.
While this might seem like a lot, it is not so bad since Ocean Wilsons Holdings has a market capitalization of US$356.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Ocean Wilsons Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.
Unfortunately, Ocean Wilsons Holdings saw its EBIT slide 3.1% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ocean Wilsons Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Ocean Wilsons Holdings 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, Ocean Wilsons Holdings produced sturdy free cash flow equating to 52% 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.
While Ocean Wilsons Holdings does have more liabilities than liquid assets, it also has net cash of US$29.9m. So we are not troubled with Ocean Wilsons Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Ocean Wilsons Holdings is showing 4 warning signs in our investment analysis , you should know about...
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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