Is American Axle & Manufacturing Holdings (NYSE:AXL) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that American Axle & Manufacturing Holdings, Inc. (NYSE:AXL) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for American Axle & Manufacturing Holdings

What Is American Axle & Manufacturing Holdings's Debt?

The image below, which you can click on for greater detail, shows that American Axle & Manufacturing Holdings had debt of US$3.27b at the end of June 2021, a reduction from US$4.20b over a year. However, it does have US$590.4m in cash offsetting this, leading to net debt of about US$2.68b.

A Look At American Axle & Manufacturing Holdings' Liabilities

According to the last reported balance sheet, American Axle & Manufacturing Holdings had liabilities of US$1.15b due within 12 months, and liabilities of US$4.25b due beyond 12 months. Offsetting these obligations, it had cash of US$590.4m as well as receivables valued at US$825.4m due within 12 months. So it has liabilities totalling US$3.99b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the US$1.06b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, American Axle & Manufacturing Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

American Axle & Manufacturing Holdings has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 2.6 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably, American Axle & Manufacturing Holdings's EBIT launched higher than Elon Musk, gaining a whopping 479% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine American Axle & Manufacturing Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, American Axle & Manufacturing Holdings produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

While American Axle & Manufacturing Holdings's level of total liabilities has us nervous. To wit both its EBIT growth rate and conversion of EBIT to free cash flow were encouraging signs. We think that American Axle & Manufacturing Holdings's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 American Axle & Manufacturing Holdings is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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