Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Above all, Wolters Kluwer AG (AMS: WKL) carries a debt. But does this debt worry shareholders?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash flow and debt together.
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What is Wolters Kluwer’s debt?
The image below, which you can click for more details, shows that in June 2021 Wolters Kluwer was in debt of € 3.02 billion, up from € 2.86 billion in a year. However, it has 951.0 million euros in cash offsetting this, which leads to net debt of around 2.06 billion euros.
Is Wolters Kluwer’s track record healthy?
According to the latest published balance sheet, Wolters Kluwer had liabilities of 2.89 billion euros at 12 months and liabilities of 3.63 billion euros over 12 months. On the other hand, it had cash of € 951.0 million and € 1.33 billion in receivables within one year. It therefore has liabilities totaling 4.24 billion euros more than its combined cash and short-term receivables.
Considering that Wolters Kluwer has a massive market cap of 25.2 billion euros, it’s hard to believe that these liabilities pose a significant threat. Having said that, it is clear that we must continue to monitor his record lest it get worse.
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 profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Wolters Kluwer’s net debt is only 1.5 times its EBITDA. And its EBIT easily covers its interest costs, being 14.0 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. While Wolters Kluwer doesn’t appear to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area you need to focus on when analyzing debt. But it’s future profits, more than anything, that will determine Wolters Kluwer’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 earnings forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years Wolters Kluwer has recorded free cash flow totaling 96% of its EBIT, which is higher than we normally expect. This positions it well to repay debt if it is desirable.
Our point of view
Wolters Kluwer’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And this is only the beginning of good news as its conversion from EBIT to free cash flow is also very encouraging. Considering all of this data, it seems to us that Wolters Kluwer is taking a pretty sane approach to debt. This means that they are taking a bit more risk, in the hope of increasing returns for shareholders. 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 off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Wolters Kluwer you should know.
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.
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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 shares 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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