Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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. We note that WESCO International, Inc. (NYSE:WCC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does WESCO International Carry?
The chart below, which you can click on for greater detail, shows that WESCO International had US$4.69b in debt in December 2021; about the same as the year before. However, because it has a cash reserve of US$212.6m, its net debt is less, at about US$4.48b.
A Look At WESCO International’s Liabilities
Zooming in on the latest balance sheet data, we can see that WESCO International had liabilities of US$3.05b due within 12 months and liabilities of US$5.79b due beyond that. Offsetting these obligations, it had cash of US$212.6m as well as receivables valued at US$3.15b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.48b.
This deficit is considerable relative to its market capitalization of US$6.00b, so it does suggest shareholders should keep an eye on WESCO International’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).
WESCO International’s debt is 3.9 times its EBITDA, and its EBIT cover its interest expense 3.7 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. The good news is that WESCO International grew its EBIT a smooth 82% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if WESCO International can strengthen its balance sheet over time.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, WESCO International’s free cash flow amounted to 37% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
Our View
WESCO International’s net debt to EBITDA and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that WESCO International is a somewhat risky investment as a result of its debt. That’s not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start.