David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, BWX Limited (ASX:BWX) does carry debt. But the more important question is: how much risk is that debt creating?
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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is BWX's Debt?
The image below, which you can click on for greater detail, shows that BWX had debt of AU$52.5m at the end of June 2021, a reduction from AU$60.5m over a year. But it also has AU$77.7m in cash to offset that, meaning it has AU$25.2m net cash.
How Healthy Is BWX's Balance Sheet?
According to the last reported balance sheet, BWX had liabilities of AU$131.2m due within 12 months, and liabilities of AU$144.2m due beyond 12 months. Offsetting these obligations, it had cash of AU$77.7m as well as receivables valued at AU$843.0k due within 12 months. So it has liabilities totalling AU$196.8m more than its cash and near-term receivables, combined.
BWX has a market capitalization of AU$750.3m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, BWX also has more cash than debt, so we're pretty confident it can manage its debt safely.
Better yet, BWX grew its EBIT by 1,537% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if BWX 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. BWX 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. In the last three years, BWX created free cash flow amounting to 8.2% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
Although BWX's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$25.2m. And we liked the look of last year's 1,537% year-on-year EBIT growth. So we are not troubled with BWX's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that BWX is showing 2 warning signs in our investment analysis , you should know about...
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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.
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