These 4 metrics indicate that WestRock (NYSE:WRK) is using debt reasonably well
David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that WestRock Company (NYSE: WRK) uses debt in its operations. But does this debt worry shareholders?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest 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 WestRock
What is WestRock’s net debt?
As you can see below, WestRock had US$8.12 billion in debt as of March 2022, up from US$8.67 billion the previous year. However, he has $360.2 million in cash to offset this, resulting in a net debt of around $7.75 billion.
How healthy is WestRock’s balance sheet?
The latest balance sheet data shows that WestRock had liabilities of $3.91 billion due within the year, and liabilities of $13.7 billion due thereafter. As compensation for these obligations, it had liquid assets of US$360.2 million as well as receivables valued at US$3.07 billion due within 12 months. Thus, its liabilities total $14.2 billion more than the combination of its cash and short-term receivables.
Given that this deficit is actually higher than the company’s massive market capitalization of $10.5 billion, we think shareholders really should be watching WestRock’s debt levels, like a parent watching their child. riding a bike for the first time. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
WestRock’s net debt is at a very reasonable 2.5 times its EBITDA, while its EBIT covered its interest expense at just 4.7 times last year. While these numbers don’t alarm us, it’s worth noting that the cost of corporate debt has a real impact. Above all, WestRock has increased its EBIT by 39% over the last twelve months, and this growth will make it easier to manage its debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine WestRock’s ability to maintain a healthy balance sheet in the future. 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. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, WestRock has generated free cash flow of a very strong 87% of its EBIT, more than expected. This puts him in a very strong position to repay his debt.
Our point of view
WestRock’s ability to convert EBIT to free cash flow and its rate of EBIT growth has given us comfort in its ability to manage its debt. On the other hand, our confidence has been shaken by his apparent struggle to manage his total liabilities. When we consider all the factors mentioned above, we feel a bit cautious about WestRock’s use of debt. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels could make the stock more risky. 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. Example: we have identified 4 warning signs for WestRock you should be aware.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.