Is Titan Cement International (ATH:TITC) Using Too Much Debt?

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 Titan Cement International S.A. (ATH:TITC) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Titan Cement International

What Is Titan Cement International's Debt?

The image below, which you can click on for greater detail, shows that Titan Cement International had debt of €827.2m at the end of March 2022, a reduction from €887.1m over a year. On the flip side, it has €70.4m in cash leading to net debt of about €756.8m.

A Look At Titan Cement International's Liabilities

We can see from the most recent balance sheet that Titan Cement International had liabilities of €467.9m falling due within a year, and liabilities of €941.2m due beyond that. Offsetting this, it had €70.4m in cash and €290.7m in receivables that were due within 12 months. So it has liabilities totalling €1.05b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of €871.6m, we think shareholders really should watch Titan Cement International's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Titan Cement International has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 3.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Even worse, Titan Cement International saw its EBIT tank 27% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Titan Cement International'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Titan Cement International actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Mulling over Titan Cement International's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Titan Cement International's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. For instance, we've identified 3 warning signs for Titan Cement International that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.