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 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 Quaker Chemical Corporation (NYSE:KWR) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Quaker Chemical's Net Debt?
As you can see below, Quaker Chemical had US$12.4m of debt at March 2019, down from US$75.4m a year prior. However, it does have US$72.0m in cash offsetting this, leading to net cash of US$59.6m.
How Healthy Is Quaker Chemical's Balance Sheet?
The latest balance sheet data shows that Quaker Chemical had liabilities of US$147.5m due within a year, and liabilities of US$114.7m falling due after that. Offsetting these obligations, it had cash of US$72.0m as well as receivables valued at US$208.0m due within 12 months. So it actually has US$17.8m more liquid assets than total liabilities.
This state of affairs indicates that Quaker Chemical's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$2.48b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Quaker Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Quaker Chemical grew its EBIT at 11% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Quaker Chemical can strengthen its balance sheet over time. 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 Quaker Chemical 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. Over the most recent three years, Quaker Chemical recorded free cash flow worth 62% 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.
While it is always sensible to investigate a company's debt, in this case Quaker Chemical has US$60m in net cash and a decent-looking balance sheet. So we don't think Quaker Chemical's use of debt is risky. We'd be motivated to research the stock further if we found out that Quaker Chemical insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
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