David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies Websol Energy System Limited (NSE: WEBELSOLAR) uses debt. But the most important question is: what risk does this debt create?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we look at debt levels, we first look at cash and debt levels, together.
See our latest review for Websol Energy System
What is the net debt of Websol Energy System?
The image below, which you can click for more details, shows that Websol Energy System had a debt of 271.2 million yen at the end of September 2021, a reduction from the 508.3 million yen. over a year. On the other hand, it has 7.80 million euros in cash, leading to a net debt of around 263.4 million euros.
A look at the responsibilities of Websol Energy System
The latest balance sheet data shows that Websol Energy System had liabilities of 574.6 million yen due within one year, and liabilities of 185.5 million yen due after that. On the other hand, it had cash of 7.80 million and 284.1 million in receivables within one year. It therefore has liabilities totaling 468.2 million yen more than its combined cash and short-term receivables.
Of course, Websol Energy System has a market cap of 2.96 billion yen, so this liability is probably manageable. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Websol Energy System has a low debt to EBITDA ratio of just 0.99. But what’s really cool is that he actually managed to earn more interest than he paid, in the last year or so. So there is no doubt that this company can go into debt and still be cool as a cucumber. Although Websol Energy System recorded a loss in EBIT, last year it was also good to see that it generated 115 million euros of EBIT in the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But it is the benefits of Websol Energy System that will influence the balance sheet in the future. So if you want to know more about its profits, it may be worth checking out this long term profit trend chart.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore important to check to what extent its earnings before interest and taxes (EBIT) are converted into actual free cash flow. Fortunately for all shareholders, Websol Energy System actually generated more free cash flow than EBIT over the past year. There is nothing better than cash flow to stay in the good graces of your lenders.
Our point of view
Fortunately, Websol Energy System’s impressive interest coverage means it has the upper hand on its debt. And the good news does not end there, since its conversion of EBIT into free cash flow also confirms this impression! When zoomed out, Websol Energy System appears to be using debt quite reasonably; and that gets the nod from us. While debt comes with risk, when used wisely, it can also generate a better return on equity. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 3 warning signs for Websol Energy System (1 is concerning!) That you should know before investing here.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.