We Think Antofagasta (LON:ANTO) Can Manage Its Debt With Ease

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Antofagasta plc (LON:ANTO) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Antofagasta

What Is Antofagasta's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Antofagasta had US$3.33b of debt, an increase on US$2.47b, over one year. However, its balance sheet shows it holds US$4.24b in cash, so it actually has US$909.9m net cash.

How Strong Is Antofagasta's Balance Sheet?

According to the last reported balance sheet, Antofagasta had liabilities of US$1.95b due within 12 months, and liabilities of US$4.81b due beyond 12 months. Offsetting this, it had US$4.24b in cash and US$697.2m in receivables that were due within 12 months. So it has liabilities totalling US$1.82b more than its cash and near-term receivables, combined.

Given Antofagasta has a humongous market capitalization of US$20.1b, 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. While it does have liabilities worth noting, Antofagasta also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Antofagasta grew its EBIT by 180% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Antofagasta 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 Antofagasta 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, Antofagasta recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

We could understand if investors are concerned about Antofagasta's liabilities, but we can be reassured by the fact it has has net cash of US$909.9m. And it impressed us with its EBIT growth of 180% over the last year. So we don't think Antofagasta's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Antofagasta is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.

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