EVRAZ (LON:EVR) Has A Pretty Healthy Balance Sheet

By
Simply Wall St
Published
December 16, 2021
LSE:EVR
Source: Shutterstock

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies EVRAZ plc (LON:EVR) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for EVRAZ

What Is EVRAZ's Net Debt?

You can click the graphic below for the historical numbers, but it shows that EVRAZ had US$4.54b of debt in June 2021, down from US$4.95b, one year before. However, it also had US$1.43b in cash, and so its net debt is US$3.11b.

debt-equity-history-analysis
LSE:EVR Debt to Equity History December 16th 2021

How Healthy Is EVRAZ's Balance Sheet?

We can see from the most recent balance sheet that EVRAZ had liabilities of US$2.64b falling due within a year, and liabilities of US$4.90b due beyond that. On the other hand, it had cash of US$1.43b and US$770.0m worth of receivables due within a year. So it has liabilities totalling US$5.34b more than its cash and near-term receivables, combined.

This deficit isn't so bad because EVRAZ is worth a massive US$11.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

EVRAZ has a low net debt to EBITDA ratio of only 0.99. And its EBIT easily covers its interest expense, being 10.3 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that EVRAZ has boosted its EBIT by 81%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine EVRAZ'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, EVRAZ recorded free cash flow worth 79% 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.

Our View

Happily, EVRAZ's impressive EBIT growth rate implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its level of total liabilities. Zooming out, EVRAZ seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for EVRAZ (of which 1 makes us a bit uncomfortable!) you should know about.

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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