Is Sherritt International (TSE:S) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that Sherritt International Corporation (TSE:S) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sherritt International

What Is Sherritt International's Debt?

The image below, which you can click on for greater detail, shows that Sherritt International had debt of CA$350.9m at the end of December 2022, a reduction from CA$444.5m over a year. However, it does have CA$123.9m in cash offsetting this, leading to net debt of about CA$227.0m.

How Healthy Is Sherritt International's Balance Sheet?

The latest balance sheet data shows that Sherritt International had liabilities of CA$367.6m due within a year, and liabilities of CA$493.1m falling due after that. Offsetting these obligations, it had cash of CA$123.9m as well as receivables valued at CA$187.3m due within 12 months. So it has liabilities totalling CA$549.5m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CA$218.5m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Sherritt International would likely require a major re-capitalisation if it had to pay its creditors today. 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 Sherritt International'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.

Over 12 months, Sherritt International reported revenue of CA$179m, which is a gain of 62%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Sherritt International still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CA$72m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. But on the bright side the company actually produced a statutory profit of CA$64m and free cash flow of CA$60m. So there is arguably potential that the company is going to turn things around. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Sherritt International you should know about.

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.