Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Over the Wire Holdings Limited (ASX:OTW) makes use of debt. But the more important question is: how much risk is that debt creating?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Over the Wire Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that Over the Wire Holdings had AU$9.55m of debt in June 2019, down from AU$13.2m, one year before. However, its balance sheet shows it holds AU$11.1m in cash, so it actually has AU$1.60m net cash.
A Look At Over the Wire Holdings's Liabilities
Zooming in on the latest balance sheet data, we can see that Over the Wire Holdings had liabilities of AU$21.7m due within 12 months and liabilities of AU$18.0m due beyond that. On the other hand, it had cash of AU$11.1m and AU$7.96m worth of receivables due within a year. So its liabilities total AU$20.6m more than the combination of its cash and short-term receivables.
Of course, Over the Wire Holdings has a market capitalization of AU$244.1m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Over the Wire Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Over the Wire Holdings grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Over the Wire Holdings'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Over the Wire Holdings 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, Over the Wire Holdings produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Over the Wire Holdings has AU$1.60m in net cash. And it impressed us with its EBIT growth of 56% over the last year. So is Over the Wire Holdings's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Over the Wire Holdings would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.