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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Weyco Group, Inc. (NASDAQ:WEYS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Weyco Group's Net Debt?
As you can see below, Weyco Group had US$5.18m of debt at September 2020, down from US$16.9m a year prior. But it also has US$8.81m in cash to offset that, meaning it has US$3.63m net cash.
How Strong Is Weyco Group's Balance Sheet?
According to the last reported balance sheet, Weyco Group had liabilities of US$26.8m due within 12 months, and liabilities of US$40.5m due beyond 12 months. Offsetting these obligations, it had cash of US$8.81m as well as receivables valued at US$43.1m due within 12 months. So it has liabilities totalling US$15.4m more than its cash and near-term receivables, combined.
Given Weyco Group has a market capitalization of US$172.9m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Weyco Group boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Weyco Group if management cannot prevent a repeat of the 66% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Weyco Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Weyco Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Weyco Group produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
We could understand if investors are concerned about Weyco Group's liabilities, but we can be reassured by the fact it has has net cash of US$3.63m. So we are not troubled with Weyco Group's debt use. 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 2 warning signs for Weyco Group you should be aware of, and 1 of them shouldn't be ignored.
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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