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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies WH Group Limited (HKG:288) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for WH Group
What Is WH Group's Net Debt?
As you can see below, WH Group had US$3.14b of debt, at December 2018, which is about the same the year before. You can click the chart for greater detail. However, it also had US$842.0m in cash, and so its net debt is US$2.30b.
A Look At WH Group's Liabilities
Zooming in on the latest balance sheet data, we can see that WH Group had liabilities of US$3.33b due within 12 months and liabilities of US$3.55b due beyond that. On the other hand, it had cash of US$842.0m and US$1.20b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.84b.
This deficit isn't so bad because WH Group is worth a massive US$13.3b, and thus could probably raise enough capital to shore up 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.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).