Outokumpu Oyj (HEL:OUT1V) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Outokumpu Oyj (HEL:OUT1V) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Outokumpu Oyj

What Is Outokumpu Oyj's Debt?

You can click the graphic below for the historical numbers, but it shows that Outokumpu Oyj had €1.09b of debt in September 2021, down from €1.52b, one year before. However, because it has a cash reserve of €345.0m, its net debt is less, at about €748.0m.

How Healthy Is Outokumpu Oyj's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Outokumpu Oyj had liabilities of €2.08b due within 12 months and liabilities of €1.34b due beyond that. On the other hand, it had cash of €345.0m and €800.0m worth of receivables due within a year. So it has liabilities totalling €2.27b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of €2.61b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Outokumpu Oyj has net debt of just 1.1 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 7.7 times the interest expense over the last year. It was also good to see that despite losing money on the EBIT line last year, Outokumpu Oyj turned things around in the last 12 months, delivering and EBIT of €485m. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Outokumpu Oyj can strengthen its balance sheet over time. 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. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Looking at the most recent year, Outokumpu Oyj recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

While Outokumpu Oyj's level of total liabilities does give us pause, its net debt to EBITDA and interest cover suggest it can stay on top of its debt load. Taking the abovementioned factors together we do think Outokumpu Oyj's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Outokumpu Oyj (at least 1 which is significant) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.