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.' 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 can see that Outokumpu Oyj (HEL:OUT1V) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Outokumpu Oyj's Debt?
As you can see below, Outokumpu Oyj had €1.22b of debt at December 2020, down from €1.29b a year prior. On the flip side, it has €402.0m in cash leading to net debt of about €818.0m.
How Healthy Is Outokumpu Oyj's Balance Sheet?
The latest balance sheet data shows that Outokumpu Oyj had liabilities of €1.82b due within a year, and liabilities of €1.62b falling due after that. On the other hand, it had cash of €402.0m and €527.0m worth of receivables due within a year. So its liabilities total €2.51b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's €1.78b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. 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 Outokumpu Oyj'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.
In the last year Outokumpu Oyj had a loss before interest and tax, and actually shrunk its revenue by 12%, to €5.6b. We would much prefer see growth.
While Outokumpu Oyj's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost €51m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of €116m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Outokumpu Oyj is showing 1 warning sign in our investment analysis , 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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