Is Water Intelligence (LON:WATR) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Water Intelligence plc (LON:WATR) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Water Intelligence

How Much Debt Does Water Intelligence Carry?

As you can see below, at the end of June 2019, Water Intelligence had US$3.86m of debt, up from US$2.70m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$6.03m in cash, so it actually has US$2.17m net cash.

AIM:WATR Historical Debt, October 18th 2019
AIM:WATR Historical Debt, October 18th 2019

How Healthy Is Water Intelligence's Balance Sheet?

We can see from the most recent balance sheet that Water Intelligence had liabilities of US$5.80m falling due within a year, and liabilities of US$4.13m due beyond that. On the other hand, it had cash of US$6.03m and US$5.98m worth of receivables due within a year. So it can boast US$2.07m more liquid assets than total liabilities.

This surplus suggests that Water Intelligence has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Water Intelligence has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, Water Intelligence grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Water Intelligence can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Water Intelligence may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Water Intelligence recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.

Summing up

While it is always sensible to investigate a company's debt, in this case Water Intelligence has US$2.17m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 29% over the last year. So we don't have any problem with Water Intelligence's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Water Intelligence insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.