Does Wärtsilä Oyj Abp (HEL:WRT1V) use too much debt?
Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, Wärtsila Oyj Abp (HEL:WRT1V) is in debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Wärtsilä Oyj Abp
What is Wärtsilä Oyj Abp’s debt?
You can click on the chart below for historical figures, but it shows Wärtsilä Oyj Abp had €776.0 million in debt in December 2021, up from €1.16 billion a year earlier. But on the other hand, it also has 964.0 million euros in cash, which leads to a net cash of 188.0 million euros.
A look at the responsibilities of Wärtsilä Oyj Abp
We can see from the most recent balance sheet that Wärtsilä Oyj Abp had liabilities of €3.05 billion due in one year, and liabilities of €1.15 billion due beyond. On the other hand, it had cash of €964.0 million and €1.83 billion in receivables at less than one year. It therefore has liabilities totaling 1.40 billion euros more than its cash and short-term receivables, combined.
While that might sound like a lot, it’s not that bad since Wärtsilä Oyj Abp has a market cap of €6.14 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution. While it has liabilities to note, Wärtsilä Oyj Abp also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Another good sign, Wärtsilä Oyj Abp was able to increase its EBIT by 23% in twelve months, thus facilitating the repayment of debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Wärtsilä Oyj Abp can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. Although Wärtsilä Oyj Abp has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it’s building (or erodes) this cash balance. Fortunately for all shareholders, Wärtsilä Oyj Abp has actually produced more free cash flow than EBIT over the past three years. There’s nothing better than incoming money to stay in the good books of your lenders.
Although Wärtsilä Oyj Abp has more debt than liquid assets, it also has a net cash position of €188.0 million. The icing on the cake was that he converted 144% of that EBIT into free cash flow, bringing in €589 million. So is Wärtsilä Oyj Abp’s debt a risk? This does not seem to us to be the case. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 2 warning signs with Wärtsilä Oyj Abp, and understanding them should be part of your investment process.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.