Wallenius Wilhelmsen (OB:WAWI) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Wallenius Wilhelmsen ASA (OB:WAWI) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Wallenius Wilhelmsen

What Is Wallenius Wilhelmsen's Debt?

You can click the graphic below for the historical numbers, but it shows that Wallenius Wilhelmsen had US$2.58b of debt in March 2022, down from US$2.70b, one year before. However, because it has a cash reserve of US$759.0m, its net debt is less, at about US$1.83b.

How Strong Is Wallenius Wilhelmsen's Balance Sheet?

The latest balance sheet data shows that Wallenius Wilhelmsen had liabilities of US$1.49b due within a year, and liabilities of US$3.48b falling due after that. Offsetting these obligations, it had cash of US$759.0m as well as receivables valued at US$524.0m due within 12 months. So its liabilities total US$3.68b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$2.80b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

While Wallenius Wilhelmsen has a quite reasonable net debt to EBITDA multiple of 2.3, its interest cover seems weak, at 2.4. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Notably, Wallenius Wilhelmsen's EBIT launched higher than Elon Musk, gaining a whopping 708% 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Wallenius Wilhelmsen actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Wallenius Wilhelmsen's conversion of EBIT to free cash flow was a real positive on this analysis, as was its EBIT growth rate. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. When we consider all the factors mentioned above, we do feel a bit cautious about Wallenius Wilhelmsen's use of debt. 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Wallenius Wilhelmsen that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.