Does Werth-Holz (WSE:WHH) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Werth-Holz S.A. (WSE:WHH) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Werth-Holz

What Is Werth-Holz's Net Debt?

As you can see below, at the end of September 2020, Werth-Holz had zł14.6m of debt, up from zł13.9m a year ago. Click the image for more detail. However, because it has a cash reserve of zł9.45m, its net debt is less, at about zł5.10m.

A Look At Werth-Holz's Liabilities

The latest balance sheet data shows that Werth-Holz had liabilities of zł20.9m due within a year, and liabilities of zł2.90m falling due after that. On the other hand, it had cash of zł9.45m and zł9.44m worth of receivables due within a year. So it has liabilities totalling zł4.94m more than its cash and near-term receivables, combined.

Of course, Werth-Holz has a market capitalization of zł24.7m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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).

Werth-Holz's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 3.6 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Werth-Holz grew its EBIT by 91% 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 you can't view debt in total isolation; since Werth-Holz will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Werth-Holz produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Werth-Holz's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its interest cover does undermine this impression a bit. When we consider the range of factors above, it looks like Werth-Holz is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. Like risks, for instance. Every company has them, and we've spotted 5 warning signs for Werth-Holz (of which 3 don't sit too well with us!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

If you’re looking to trade Werth-Holz, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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