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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that West Pharmaceutical Services, Inc. (NYSE:WST) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does West Pharmaceutical Services Carry?
As you can see below, West Pharmaceutical Services had US$254.1m of debt, at September 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$688.0m in cash, so it actually has US$433.9m net cash.
A Look At West Pharmaceutical Services' Liabilities
Zooming in on the latest balance sheet data, we can see that West Pharmaceutical Services had liabilities of US$558.6m due within 12 months and liabilities of US$381.7m due beyond that. On the other hand, it had cash of US$688.0m and US$476.4m worth of receivables due within a year. So it can boast US$224.1m 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$29.1b 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!
In addition to that, we're happy to report that West Pharmaceutical Services has boosted its EBIT by 84%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if West Pharmaceutical Services can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 62% 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.
While it is always sensible to investigate a company's debt, in this case West Pharmaceutical Services has US$433.9m in net cash and a decent-looking balance sheet. And we liked the look of last year's 84% year-on-year EBIT growth. So we don't think West Pharmaceutical Services's use of debt is risky. 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 you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.