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.' 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 Ocean Wilsons Holdings Limited (LON:OCN) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Ocean Wilsons Holdings's Debt?
The chart below, which you can click on for greater detail, shows that Ocean Wilsons Holdings had US$342.7m in debt in December 2020; about the same as the year before. However, it does have US$410.7m in cash offsetting this, leading to net cash of US$68.1m.
A Look At Ocean Wilsons Holdings' Liabilities
Zooming in on the latest balance sheet data, we can see that Ocean Wilsons Holdings had liabilities of US$124.3m due within 12 months and liabilities of US$485.9m due beyond that. Offsetting these obligations, it had cash of US$410.7m as well as receivables valued at US$64.7m due within 12 months. So it has liabilities totalling US$134.7m more than its cash and near-term receivables, combined.
Ocean Wilsons Holdings has a market capitalization of US$533.6m, 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, Ocean Wilsons Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Sadly, Ocean Wilsons Holdings's EBIT actually dropped 9.0% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 Ocean Wilsons Holdings'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ocean Wilsons Holdings 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. Looking at the most recent three years, Ocean Wilsons Holdings recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Although Ocean Wilsons Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$68.1m. So we are not troubled with Ocean Wilsons Holdings's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Ocean Wilsons Holdings has 4 warning signs (and 1 which is concerning) we think you should know about.
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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