Is West Pharmaceutical Services (NYSE:WST) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, West Pharmaceutical Services, Inc. (NYSE:WST) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

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$206.8m of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has US$853.9m in cash to offset that, meaning it has US$647.1m 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$671.8m falling due within a year, and liabilities of US$276.7m due beyond that. On the other hand, it had cash of US$853.9m and US$533.5m worth of receivables due within a year. So it can boast US$438.9m more liquid assets than total liabilities.

This state of affairs indicates that West Pharmaceutical Services' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$26.2b company is short on cash, but still worth keeping an eye on the 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.

But the other side of the story is that West Pharmaceutical Services saw its EBIT decline by 7.4% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. West Pharmaceutical Services 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, West Pharmaceutical Services recorded free cash flow worth 53% 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 investigate a company's debt, in this case West Pharmaceutical Services has US$647.1m in net cash and a decent-looking balance sheet. So we are not troubled with West Pharmaceutical Services's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of West Pharmaceutical Services's earnings per share history for free.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.