Metall Zug (VTX:METN) Takes On Some Risk With Its Use Of Debt

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 note that Metall Zug AG (VTX:METN) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Metall Zug

How Much Debt Does Metall Zug Carry?

You can click the graphic below for the historical numbers, but it shows that Metall Zug had CHF4.58m of debt in June 2021, down from CHF13.7m, one year before. However, it does have CHF90.2m in cash offsetting this, leading to net cash of CHF85.6m.

How Healthy Is Metall Zug's Balance Sheet?

According to the last reported balance sheet, Metall Zug had liabilities of CHF154.6m due within 12 months, and liabilities of CHF39.7m due beyond 12 months. Offsetting these obligations, it had cash of CHF90.2m as well as receivables valued at CHF116.8m due within 12 months. So it can boast CHF12.7m more liquid assets than total liabilities.

Having regard to Metall Zug's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CHF874.1m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Metall Zug has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Metall Zug's load is not too heavy, because its EBIT was down 25% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Metall Zug'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Metall Zug 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, Metall Zug saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Metall Zug has net cash of CHF85.6m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Metall Zug's balance sheet. Over time, share prices tend to follow earnings per share, so if you're interested in Metall Zug, you may well want to click here to check an interactive graph of its earnings per share history.

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.