Is Wallenius Wilhelmsen (OB:WAWI) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Wallenius Wilhelmsen ASA (OB:WAWI) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Wallenius Wilhelmsen

What Is Wallenius Wilhelmsen's Debt?

As you can see below, Wallenius Wilhelmsen had US$2.56b of debt, at June 2022, 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$821.0m, its net debt is less, at about US$1.74b.

How Strong Is Wallenius Wilhelmsen's Balance Sheet?

The latest balance sheet data shows that Wallenius Wilhelmsen had liabilities of US$2.12b due within a year, and liabilities of US$2.91b falling due after that. On the other hand, it had cash of US$821.0m and US$570.0m worth of receivables due within a year. So its liabilities total US$3.64b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$2.34b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Wallenius Wilhelmsen would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Wallenius Wilhelmsen has net debt worth 1.9 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.0 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably, Wallenius Wilhelmsen's EBIT launched higher than Elon Musk, gaining a whopping 314% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Wallenius Wilhelmsen 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Wallenius Wilhelmsen actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

While Wallenius Wilhelmsen's level of total liabilities has us nervous. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Wallenius Wilhelmsen is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Wallenius Wilhelmsen you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.