West Pharmaceutical Services (NYSE:WST) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, '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, West Pharmaceutical Services, Inc. (NYSE:WST) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out the opportunities and risks within the US Life Sciences industry.

How Much Debt Does West Pharmaceutical Services Carry?

The chart below, which you can click on for greater detail, shows that West Pharmaceutical Services had US$252.0m in debt in June 2022; about the same as the year before. But on the other hand it also has US$718.5m in cash, leading to a US$466.5m net cash position.

A Look At West Pharmaceutical Services' Liabilities

According to the last reported balance sheet, West Pharmaceutical Services had liabilities of US$565.1m due within 12 months, and liabilities of US$372.2m due beyond 12 months. On the other hand, it had cash of US$718.5m and US$528.4m worth of receivables due within a year. So it actually has US$309.6m 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 while it's hard to imagine that the US$17.5b 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.

Also positive, West Pharmaceutical Services grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. 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 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 55% 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 we empathize with investors who find debt concerning, you should keep in mind that West Pharmaceutical Services has net cash of US$466.5m, as well as more liquid assets than liabilities. And we liked the look of last year's 25% year-on-year EBIT growth. So we don't think West Pharmaceutical Services's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for West Pharmaceutical Services you should know about.

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.