Does Wilmington (LON: WIL) have a healthy track record?

Howard Marks put 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 every investor practice that I know is worried. When we think about how risky a business is, we always like to look at its use of debt, because overloading debt can lead to bankruptcy. We notice that Wilmington plc (LON: WIL) has debt on her balance sheet. But the real question is whether this debt makes the business risky.

When is Debt a Problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.

See our latest analysis for Wilmington

What is Wilmington’s net debt?

The image below, which you can click for more details, shows Wilmington owed £ 24.1million at the end of June 2021, a reduction from £ 48.6million on a year. However, he has £ 7.37million in cash offsetting this, leading to net debt of around £ 16.7million.

LSE: WIL Debt to equity history December 17, 2021

A look at Wilmington’s responsibilities

According to the latest published balance sheet, Wilmington had debts of £ 61.4million due within 12 months and debt of £ 32.3million due beyond 12 months. In return, he had £ 7.37million in cash and £ 23.8million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by £ 62.5 million.

This deficit is not that big as Wilmington is worth £ 179.7million and therefore could possibly raise enough capital to consolidate its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.

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). Thus, we look at debt versus earnings with and without amortization expenses.

With net debt of just 0.94 times EBITDA, Wilmington is arguably fairly cautious. And it has 7.5 times interest coverage, which is more than enough. On top of that, Wilmington has grown its EBIT by 43% over the past twelve months, and that growth will make it easier to process its debt. When analyzing debt levels, the balance sheet is the obvious place to start. But it’s future profits, more than anything, that will determine Wilmington’s ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.

Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Fortunately for all shareholders, Wilmington has actually generated more free cash flow than EBIT over the past three years. This kind of cash conversion makes us as excited as the crowd when the pace drops at a Daft Punk concert.

Our point of view

Wilmington’s EBIT conversion to free cash flow suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And that’s just the start of good news as its EBIT growth rate is also very encouraging. Looking at the big picture, we think Wilmington’s use of debt looks very reasonable and we don’t care. While debt comes with risk, when used wisely, it can also generate a better return on equity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. We have identified 2 warning signs with Wilmington and understanding them should be part of your investment process.

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

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.

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