Watts International Maritime Engineering (HKG:2258) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Watts International Maritime Engineering Limited (HKG:2258) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Watts International Maritime Engineering

What Is Watts International Maritime Engineering's Debt?

The image below, which you can click on for greater detail, shows that Watts International Maritime Engineering had debt of CN¥54.0m at the end of December 2020, a reduction from CN¥58.5m over a year. However, it does have CN¥423.7m in cash offsetting this, leading to net cash of CN¥369.7m.

How Strong Is Watts International Maritime Engineering's Balance Sheet?

We can see from the most recent balance sheet that Watts International Maritime Engineering had liabilities of CN¥2.48b falling due within a year, and liabilities of CN¥284.8m due beyond that. Offsetting these obligations, it had cash of CN¥423.7m as well as receivables valued at CN¥2.09b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥251.7m.

This deficit is considerable relative to its market capitalization of CN¥389.5m, so it does suggest shareholders should keep an eye on Watts International Maritime Engineering's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Watts International Maritime Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Watts International Maritime Engineering's EBIT fell a jaw-dropping 29% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Watts International Maritime Engineering's earnings that will influence how the balance sheet holds up in the future. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Watts International Maritime Engineering 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. In the last three years, Watts International Maritime Engineering's free cash flow amounted to 47% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Watts International Maritime Engineering's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥369.7m. So although we see some areas for improvement, we're not too worried about Watts International Maritime Engineering's balance sheet. 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. Case in point: We've spotted 5 warning signs for Watts International Maritime Engineering you should be aware of.

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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