Does WISE Finance (WSE:IBS) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, WISE Finance S.A. (WSE:IBS) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for WISE Finance

What Is WISE Finance's Net Debt?

As you can see below, at the end of September 2023, WISE Finance had zł56.1m of debt, up from zł46.7m a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

How Strong Is WISE Finance's Balance Sheet?

The latest balance sheet data shows that WISE Finance had liabilities of zł53.1m due within a year, and liabilities of zł22.3m falling due after that. Offsetting these obligations, it had cash of zł103.0k as well as receivables valued at zł102.5m due within 12 months. So it actually has zł27.3m more liquid assets than total liabilities.

This excess liquidity is a great indication that WISE Finance's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master.

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).

As it happens WISE Finance has a fairly concerning net debt to EBITDA ratio of 12.6 but very strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Importantly, WISE Finance's EBIT fell a jaw-dropping 32% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since WISE Finance 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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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 two years, WISE Finance reported free cash flow worth 15% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

We weren't impressed with WISE Finance's net debt to EBITDA, and its EBIT growth rate made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble covering its interest expense with its EBIT. Considering this range of data points, we think WISE Finance is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. These risks can be hard to spot. Every company has them, and we've spotted 6 warning signs for WISE Finance (of which 2 are concerning!) you should know about.

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.