WH Group (HKG:288) Seems To Use Debt Quite Sensibly

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies WH Group Limited (HKG:288) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for WH Group

What Is WH Group's Net Debt?

As you can see below, WH Group had US$3.37b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$1.40b, its net debt is less, at about US$1.98b.

How Strong Is WH Group's Balance Sheet?

The latest balance sheet data shows that WH Group had liabilities of US$4.04b due within a year, and liabilities of US$4.11b falling due after that. Offsetting this, it had US$1.40b in cash and US$921.0m in receivables that were due within 12 months. So its liabilities total US$5.83b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since WH Group has a huge market capitalization of US$10.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 1.1 times EBITDA, WH Group is arguably pretty conservatively geared. And it boasts interest cover of 10.0 times, which is more than adequate. On top of that, WH Group grew its EBIT by 82% over the last twelve months, and that growth will make it easier to handle its debt. 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 WH 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, WH Group recorded free cash flow worth a fulsome 84% 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, WH Group'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, WH Group seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns 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. Case in point: We've spotted 2 warning signs for WH Group you should be aware of.

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.