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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Watkin Jones Plc (LON:WJG) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Watkin Jones's Net Debt?
As you can see below, at the end of September 2020, Watkin Jones had UK£39.7m of debt, up from UK£37.4m a year ago. Click the image for more detail. But on the other hand it also has UK£134.5m in cash, leading to a UK£94.8m net cash position.
A Look At Watkin Jones' Liabilities
The latest balance sheet data shows that Watkin Jones had liabilities of UK£120.4m due within a year, and liabilities of UK£171.7m falling due after that. On the other hand, it had cash of UK£134.5m and UK£65.0m worth of receivables due within a year. So it has liabilities totalling UK£92.6m more than its cash and near-term receivables, combined.
Since publicly traded Watkin Jones shares are worth a total of UK£513.0m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Watkin Jones boasts net cash, so it's fair to say it does not have a heavy debt load!
Watkin Jones's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Watkin Jones'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. Watkin Jones 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. During the last three years, Watkin Jones produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While Watkin Jones does have more liabilities than liquid assets, it also has net cash of UK£94.8m. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in UK£38m. So we don't have any problem with Watkin Jones's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 4 warning signs we've spotted with Watkin Jones .
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.
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. 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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