We Think West Pharmaceutical Services (NYSE:WST) Can Manage Its Debt With Ease

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 West Pharmaceutical Services, Inc. (NYSE:WST) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for West Pharmaceutical Services

What Is West Pharmaceutical Services's Net Debt?

As you can see below, West Pharmaceutical Services had US$254.6m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$483.7m in cash, so it actually has US$229.1m net cash.

A Look At West Pharmaceutical Services' Liabilities

We can see from the most recent balance sheet that West Pharmaceutical Services had liabilities of US$482.8m falling due within a year, and liabilities of US$427.9m due beyond that. Offsetting these obligations, it had cash of US$483.7m as well as receivables valued at US$465.7m due within 12 months. So it actually has US$38.7m more liquid assets than total liabilities.

Having regard to West Pharmaceutical Services' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$24.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that West Pharmaceutical Services has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that West Pharmaceutical Services has boosted its EBIT by 65%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine West Pharmaceutical Services'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 West Pharmaceutical Services 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, West Pharmaceutical Services recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case West Pharmaceutical Services has US$229.1m in net cash and a decent-looking balance sheet. And we liked the look of last year's 65% year-on-year EBIT growth. So is West Pharmaceutical Services's debt a risk? It doesn't seem so to us. 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 - West Pharmaceutical Services has 1 warning sign we think you should be aware of.

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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