Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that West Pharmaceutical Services, Inc. (NYSE:WST) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

What Is West Pharmaceutical Services's Net Debt?

As you can see below, West Pharmaceutical Services had US$205.8m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has US$446.2m in cash to offset that, meaning it has US$240.4m net cash.

How Strong Is West Pharmaceutical Services' Balance Sheet?

According to the last reported balance sheet, West Pharmaceutical Services had liabilities of US$633.7m due within 12 months, and liabilities of US$278.9m due beyond 12 months. Offsetting these obligations, it had cash of US$446.2m as well as receivables valued at US$502.0m due within 12 months. So it can boast US$35.6m more liquid assets than total liabilities.

This state of affairs indicates that West Pharmaceutical Services' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$22.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, West Pharmaceutical Services boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that West Pharmaceutical Services has seen its EBIT plunge 14% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine West Pharmaceutical Services's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While West Pharmaceutical Services has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, West Pharmaceutical Services produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case West Pharmaceutical Services has US$240.4m in net cash and a decent-looking balance sheet. So we don't have any problem with West Pharmaceutical Services's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of West Pharmaceutical Services's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.