Is Westinghouse Air Brake Technologies (NYSE:WAB) A Risky Investment?

Simply Wall St
May 04, 2022
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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 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. As with many other companies Westinghouse Air Brake Technologies Corporation (NYSE:WAB) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Westinghouse Air Brake Technologies

What Is Westinghouse Air Brake Technologies's Debt?

As you can see below, Westinghouse Air Brake Technologies had US$4.24b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has US$488.0m in cash leading to net debt of about US$3.75b.

NYSE:WAB Debt to Equity History May 4th 2022

A Look At Westinghouse Air Brake Technologies' Liabilities

Zooming in on the latest balance sheet data, we can see that Westinghouse Air Brake Technologies had liabilities of US$2.88b due within 12 months and liabilities of US$5.47b due beyond that. Offsetting these obligations, it had cash of US$488.0m as well as receivables valued at US$1.38b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.48b.

Westinghouse Air Brake Technologies has a very large market capitalization of US$16.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Westinghouse Air Brake Technologies's debt is 2.6 times its EBITDA, and its EBIT cover its interest expense 5.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. One way Westinghouse Air Brake Technologies could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 20%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Westinghouse Air Brake Technologies 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.

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. Over the last three years, Westinghouse Air Brake Technologies recorded free cash flow worth a fulsome 86% 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

Westinghouse Air Brake Technologies's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. When we consider the range of factors above, it looks like Westinghouse Air Brake Technologies is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Westinghouse Air Brake Technologies that you should be aware of before investing here.

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.

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