Is Watts Water Technologies (NYSE:WTS) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, Watts Water Technologies, Inc. (NYSE:WTS) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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 the opportunities and risks within the US Machinery industry.

What Is Watts Water Technologies's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Watts Water Technologies had US$182.4m of debt, an increase on US$152.5m, over one year. However, its balance sheet shows it holds US$222.5m in cash, so it actually has US$40.1m net cash.

A Look At Watts Water Technologies' Liabilities

The latest balance sheet data shows that Watts Water Technologies had liabilities of US$378.5m due within a year, and liabilities of US$299.4m falling due after that. Offsetting these obligations, it had cash of US$222.5m as well as receivables valued at US$257.0m due within 12 months. So its liabilities total US$198.4m more than the combination of its cash and short-term receivables.

Given Watts Water Technologies has a market capitalization of US$5.06b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Watts Water Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Watts Water Technologies grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Watts Water Technologies 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Watts Water Technologies may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Watts Water Technologies recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Watts Water Technologies's liabilities, but we can be reassured by the fact it has has net cash of US$40.1m. And it impressed us with its EBIT growth of 25% over the last year. So we don't think Watts Water Technologies's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Watts Water Technologies that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.