Howard Marks said 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 that every practical investor that I know is worried”. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Aurubis S.A. (ETR:NDA) uses debt in its business. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great 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 and debt together.
See our latest analysis for Aurubis
What is Aurubis’ debt?
The image below, which you can click on for more details, shows that Aurubis had a debt of €249.0m at the end of June 2022, compared to €505.0m over one year. However, his balance sheet shows that he holds €449.0 million in cash, so he actually has €200.0 million in net cash.
How healthy is Aurubis’ balance sheet?
The latest balance sheet data shows that Aurubis had liabilities of €2.26 billion maturing within the year, and liabilities of €1.08 billion maturing thereafter. In compensation for these obligations, it had cash of €449.0 million as well as receivables worth €1.16 billion at less than 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €1.73 billion.
That’s a mountain of leverage compared to its market capitalization of 2.82 billion euros. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution. While he has liabilities worth noting, Aurubis also has more cash than debt, so we’re pretty confident he can manage his debt safely.
Fortunately, Aurubis has increased its EBIT by 8.4% over the past year, which makes this debt even more manageable. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Aurubis can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. Although Aurubis has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how fast it’s building ( or erodes) this cash balance. . Over the past three years, Aurubis has produced strong free cash flow equivalent to 51% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Although Aurubis has more liabilities than liquid assets, it also has a net cash position of 200.0 million euros. On top of that, it has increased its EBIT by 8.4% over the last twelve months. So we have no problem with Aurubis’ use of debt. 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 outside of the balance sheet. To this end, you should be aware of the 1 warning sign we spotted with Aurubis.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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