Is West Pharmaceutical Services (NYSE:WST) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See 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$208.3m of debt at March 2023, down from US$252.5m a year prior. But on the other hand it also has US$886.3m in cash, leading to a US$678.0m net cash position.

How Healthy Is West Pharmaceutical Services' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that West Pharmaceutical Services had liabilities of US$534.9m due within 12 months and liabilities of US$412.5m due beyond that. On the other hand, it had cash of US$886.3m and US$532.8m worth of receivables due within a year. So it actually has US$471.7m 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 it's very unlikely that the US$26.4b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, West Pharmaceutical Services boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, West Pharmaceutical Services saw its EBIT drop by 4.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. 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, a company can only pay off debt with cold hard cash, not accounting profits. 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 54% 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$678.0m in net cash and a decent-looking balance sheet. So we don't have any problem with West Pharmaceutical Services's use of debt. 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. Case in point: We've spotted 1 warning sign for West Pharmaceutical Services you should be aware of.

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.