Is Wincanton (LON:WIN) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Wincanton plc (LON:WIN) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Wincanton

What Is Wincanton's Debt?

As you can see below, at the end of September 2021, Wincanton had UK£40.0m of debt, up from none a year ago. Click the image for more detail. However, because it has a cash reserve of UK£23.6m, its net debt is less, at about UK£16.4m.

How Strong Is Wincanton's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wincanton had liabilities of UK£344.8m due within 12 months and liabilities of UK£218.3m due beyond that. Offsetting these obligations, it had cash of UK£23.6m as well as receivables valued at UK£191.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£347.8m.

This deficit is considerable relative to its market capitalization of UK£489.7m, so it does suggest shareholders should keep an eye on Wincanton's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Wincanton's net debt is only 0.21 times its EBITDA. And its EBIT easily covers its interest expense, being 11.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Wincanton grew its EBIT by 69% over the last twelve months, and that growth will make it easier to handle its 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 Wincanton can strengthen its balance sheet over time. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Wincanton recorded free cash flow worth a fulsome 93% 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

Happily, Wincanton's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its level of total liabilities. Zooming out, Wincanton seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. Be aware that Wincanton is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.