We Think Westlake (NYSE:WLK) Can Stay On Top Of Its Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Westlake Corporation (NYSE:WLK) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Westlake

What Is Westlake's Net Debt?

As you can see below, Westlake had US$4.89b of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. However, it also had US$2.68b in cash, and so its net debt is US$2.22b.

A Look At Westlake's Liabilities

The latest balance sheet data shows that Westlake had liabilities of US$2.13b due within a year, and liabilities of US$7.77b falling due after that. Offsetting these obligations, it had cash of US$2.68b as well as receivables valued at US$1.86b due within 12 months. So its liabilities total US$5.37b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Westlake is worth a massive US$16.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Westlake has a low net debt to EBITDA ratio of only 0.79. And its EBIT covers its interest expense a whopping 12.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Westlake's saving grace is its low debt levels, because its EBIT has tanked 54% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Westlake 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Westlake produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Westlake's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Westlake is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Westlake 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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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.