Here's Why Antofagasta (LON:ANTO) Can Manage Its Debt Responsibly

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. As with many other companies Antofagasta plc (LON:ANTO) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Antofagasta

What Is Antofagasta's Debt?

As you can see below, at the end of December 2024, Antofagasta had US$5.79b of debt, up from US$3.85b a year ago. Click the image for more detail. However, it does have US$4.32b in cash offsetting this, leading to net debt of about US$1.47b.

How Healthy Is Antofagasta's Balance Sheet?

We can see from the most recent balance sheet that Antofagasta had liabilities of US$2.78b falling due within a year, and liabilities of US$6.91b due beyond that. Offsetting this, it had US$4.32b in cash and US$916.9m in receivables that were due within 12 months. So its liabilities total US$4.45b more than the combination of its cash and short-term receivables.

Given Antofagasta has a humongous market capitalization of US$22.5b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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).

Antofagasta's net debt is only 0.46 times its EBITDA. And its EBIT covers its interest expense a whopping 12.6 times over. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Antofagasta saw its EBIT decline by 8.4% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Antofagasta 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Antofagasta barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

Both Antofagasta's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. Looking at all this data makes us feel a little cautious about Antofagasta's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 Antofagasta 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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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.