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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.' 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 World Fuel Services Corporation (NYSE:INT) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is World Fuel Services's Net Debt?
The image below, which you can click on for greater detail, shows that World Fuel Services had debt of US$473.6m at the end of September 2020, a reduction from US$671.1m over a year. But on the other hand it also has US$572.7m in cash, leading to a US$99.1m net cash position.
How Healthy Is World Fuel Services' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that World Fuel Services had liabilities of US$1.56b due within 12 months and liabilities of US$915.5m due beyond that. Offsetting these obligations, it had cash of US$572.7m as well as receivables valued at US$1.24b due within 12 months. So its liabilities total US$655.7m more than the combination of its cash and short-term receivables.
World Fuel Services has a market capitalization of US$2.11b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, World Fuel Services also has more cash than debt, so we're pretty confident it can manage its debt safely.
Importantly, World Fuel Services's EBIT fell a jaw-dropping 32% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine World Fuel Services'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, a company can only pay off debt with cold hard cash, not accounting profits. While World Fuel Services 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. In the last three years, World Fuel Services's free cash flow amounted to 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Although World Fuel Services'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$99.1m. So although we see some areas for improvement, we're not too worried about World Fuel Services's balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for World Fuel Services you should be aware of, and 1 of them can't be ignored.
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. 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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