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. As with many other companies WidePoint Corporation (NYSEMKT:WYY) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is WidePoint's Net Debt?
You can click the graphic below for the historical numbers, but it shows that WidePoint had US$36.0k of debt in June 2019, down from US$190k, one year before. But on the other hand it also has US$5.42m in cash, leading to a US$5.39m net cash position.
A Look At WidePoint's Liabilities
We can see from the most recent balance sheet that WidePoint had liabilities of US$21.5m falling due within a year, and liabilities of US$7.50m due beyond that. Offsetting these obligations, it had cash of US$5.42m as well as receivables valued at US$19.1m due within 12 months. So its liabilities total US$4.41m more than the combination of its cash and short-term receivables.
Since publicly traded WidePoint shares are worth a total of US$29.5m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, WidePoint boasts net cash, so it's fair to say it does not have a heavy debt load!
Notably, WidePoint made a loss at the EBIT level, last year, but improved that to positive EBIT of US$997k in the last twelve months. 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 WidePoint 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. WidePoint 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. Over the most recent year, WidePoint recorded free cash flow worth 52% 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.
Although WidePoint's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$5.39m. So we don't have any problem with WidePoint's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that WidePoint insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying 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.