We Think Outokumpu Oyj (HEL:OUT1V) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Outokumpu Oyj (HEL:OUT1V) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Outokumpu Oyj

What Is Outokumpu Oyj's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Outokumpu Oyj had €547.0m of debt in March 2023, down from €819.0m, one year before. But it also has €714.0m in cash to offset that, meaning it has €167.0m net cash.

A Look At Outokumpu Oyj's Liabilities

Zooming in on the latest balance sheet data, we can see that Outokumpu Oyj had liabilities of €1.97b due within 12 months and liabilities of €765.0m due beyond that. Offsetting this, it had €714.0m in cash and €876.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.15b.

While this might seem like a lot, it is not so bad since Outokumpu Oyj has a market capitalization of €2.33b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Outokumpu Oyj boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Outokumpu Oyj saw its EBIT decline by 5.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Over the most recent three years, Outokumpu Oyj recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although Outokumpu Oyj's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €167.0m. And it impressed us with free cash flow of €566m, being 78% of its EBIT. So we don't have any problem with Outokumpu Oyj's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Outokumpu Oyj (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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.