These 4 Measures Indicate That Outokumpu Oyj (HEL:OUT1V) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. 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?

As you can see below, Outokumpu Oyj had €399.0m of debt at June 2023, down from €762.0m a year prior. But on the other hand it also has €409.0m in cash, leading to a €10.0m net cash position.

How Healthy Is Outokumpu Oyj's Balance Sheet?

According to the last reported balance sheet, Outokumpu Oyj had liabilities of €1.66b due within 12 months, and liabilities of €704.0m due beyond 12 months. On the other hand, it had cash of €409.0m and €854.0m worth of receivables due within a year. So its liabilities total €1.10b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of €1.84b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Outokumpu Oyj also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Outokumpu Oyj if management cannot prevent a repeat of the 50% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Outokumpu Oyj can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Outokumpu Oyj 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, Outokumpu Oyj produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Outokumpu Oyj does have more liabilities than liquid assets, it also has net cash of €10.0m. And it impressed us with free cash flow of €480m, being 72% of its EBIT. So we don't have any problem with Outokumpu Oyj's use of debt. 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. Be aware that Outokumpu Oyj is showing 2 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.