Watts Water Technologies (NYSE:WTS) Could Easily Take On More Debt

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.' 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 Watts Water Technologies, Inc. (NYSE:WTS) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Watts Water Technologies

How Much Debt Does Watts Water Technologies Carry?

The image below, which you can click on for greater detail, shows that Watts Water Technologies had debt of US$152.5m at the end of September 2021, a reduction from US$249.1m over a year. But on the other hand it also has US$238.7m in cash, leading to a US$86.2m net cash position.

How Strong Is Watts Water Technologies' Balance Sheet?

We can see from the most recent balance sheet that Watts Water Technologies had liabilities of US$417.8m falling due within a year, and liabilities of US$295.3m due beyond that. Offsetting these obligations, it had cash of US$238.7m as well as receivables valued at US$243.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$231.2m.

Given Watts Water Technologies has a market capitalization of US$6.53b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Watts Water Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Watts Water Technologies has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. 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 last three years, Watts Water Technologies recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Watts Water Technologies has US$86.2m in net cash. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in US$207m. So we don't think Watts Water Technologies's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. 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 1 warning sign for Watts Water Technologies you should know about.

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.

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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.