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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Watts Water Technologies, Inc. (NYSE:WTS) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, 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

What Is Watts Water Technologies's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Watts Water Technologies had US$142.5m of debt in December 2021, down from US$198.8m, one year before. But it also has US$242.0m in cash to offset that, meaning it has US$99.5m net cash.

How Healthy Is Watts Water Technologies' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Watts Water Technologies had liabilities of US$408.5m due within 12 months and liabilities of US$273.9m due beyond that. Offsetting these obligations, it had cash of US$242.0m as well as receivables valued at US$220.9m due within 12 months. So its liabilities total US$219.5m more than the combination of its cash and short-term receivables.

Given Watts Water Technologies has a market capitalization of US$4.46b, 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 33%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Watts Water Technologies's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Watts Water Technologies has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Watts Water Technologies recorded free cash flow worth 77% 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

While it is always sensible to look at a company's total liabilities, it is very reassuring that Watts Water Technologies has US$99.5m in net cash. And we liked the look of last year's 33% year-on-year EBIT growth. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Watts Water Technologies you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.