We Think BHP Group (ASX:BHP) Can Manage Its Debt With Ease

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that BHP Group Limited (ASX:BHP) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for BHP Group

How Much Debt Does BHP Group Carry?

The image below, which you can click on for greater detail, shows that BHP Group had debt of US$15.7b at the end of June 2022, a reduction from US$17.7b over a year. But it also has US$17.5b in cash to offset that, meaning it has US$1.86b net cash.

A Look At BHP Group's Liabilities

Zooming in on the latest balance sheet data, we can see that BHP Group had liabilities of US$16.9b due within 12 months and liabilities of US$29.5b due beyond that. Offsetting these obligations, it had cash of US$17.5b as well as receivables valued at US$5.69b due within 12 months. So its liabilities total US$23.2b more than the combination of its cash and short-term receivables.

Of course, BHP Group has a titanic market capitalization of US$125.7b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, BHP Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that BHP Group grew its EBIT by 14% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine BHP Group'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 report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While BHP Group 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, BHP Group produced sturdy free cash flow equating to 76% 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 BHP Group does have more liabilities than liquid assets, it also has net cash of US$1.86b. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in US$26b. So is BHP Group's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for BHP Group (1 is significant) you should be aware of.

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.

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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.