Is BWG (OB:BWLPG) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, BW LPG Limited (OB:BWLPG) does carry debt. But the more important question is: how much risk is that debt creating?

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What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is BWG's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 BWG had US$942.0m of debt, an increase on US$412.3m, over one year. However, it does have US$282.5m in cash offsetting this, leading to net debt of about US$659.6m.

How Strong Is BWG's Balance Sheet?

According to the last reported balance sheet, BWG had liabilities of US$610.1m due within 12 months, and liabilities of US$772.8m due beyond 12 months. Offsetting these obligations, it had cash of US$282.5m as well as receivables valued at US$184.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$916.4m.

This is a mountain of leverage relative to its market capitalization of US$1.34b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

Check out our latest analysis for BWG

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).

BWG's net debt is only 1.3 times its EBITDA. And its EBIT covers its interest expense a whopping 114 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, BWG's EBIT dived 15%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine BWG's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts .

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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, BWG recorded free cash flow worth a fulsome 88% 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

Both BWG's ability to to cover its interest expense with its EBIT and its conversion of EBIT to free cash flow gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to grow its EBIT. Looking at all this data makes us feel a little cautious about BWG's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. To that end, you should learn about the 4 warning signs we've spotted with BWG (including 2 which are a bit unpleasant) .

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.