John Wood Group (LON:WG.) Has a somewhat stretched balance sheet
Warren Buffett said: “Volatility is far from synonymous with risk. 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. We can see that John Wood Group PLC (LON:WG.) uses debt in its business. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for John Wood Group
How much debt does the John Wood Group carry?
You can click on the graph below for historical numbers, but it shows that in December 2021, John Wood Group had $1.90 billion in debt, an increase from $1.63 billion, on a year. However, he also had $503.0 million in cash, so his net debt is $1.40 billion.
How strong is John Wood Group’s balance sheet?
According to the last published balance sheet, John Wood Group had liabilities of US$2.74 billion due within 12 months and liabilities of US$2.77 billion due beyond 12 months. In return, it had $503.0 million in cash and $1.74 billion in receivables due within 12 months. It therefore has liabilities totaling $3.27 billion more than its cash and short-term receivables, combined.
The deficiency here weighs heavily on the $1.71 billion business itself, like a child struggling under the weight of a huge backpack full of books, his gym gear and a trumpet. . We would therefore be watching his balance sheet closely, no doubt. Ultimately, John Wood Group would likely need a major recapitalization if its creditors were to demand repayment.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
While we are not concerned about John Wood Group’s net debt to EBITDA ratio of 4.9, we believe its extremely low interest coverage of 1.4 times is a sign of high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Worse still, John Wood Group has seen its EBIT drop 36% in the past 12 months. If profits continue like this in the long term, there is an unimaginable chance of repaying this debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether John Wood Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, John Wood Group has recorded free cash flow of 75% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
At first glance, John Wood Group’s EBIT growth rate left us hesitant about the stock, and its level of total liabilities was no more appealing than the single empty restaurant on the busiest night of the year. . But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. Overall, it seems to us that John Wood Group’s balance sheet is really a risk for the company. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example – John Wood Group has 1 warning sign we think you should know.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.
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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.