Is American Axle & Manufacturing Holdings (NYSE:AXL) 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. As with many other companies American Axle & Manufacturing Holdings, Inc. (NYSE:AXL) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for American Axle & Manufacturing Holdings

What Is American Axle & Manufacturing Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that American Axle & Manufacturing Holdings had US$2.90b of debt in March 2023, down from US$3.09b, one year before. However, because it has a cash reserve of US$466.8m, its net debt is less, at about US$2.43b.

How Healthy Is American Axle & Manufacturing Holdings' Balance Sheet?

According to the last reported balance sheet, American Axle & Manufacturing Holdings had liabilities of US$1.20b due within 12 months, and liabilities of US$3.63b due beyond 12 months. Offsetting these obligations, it had cash of US$466.8m as well as receivables valued at US$892.1m due within 12 months. So it has liabilities totalling US$3.47b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$856.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While we wouldn't worry about American Axle & Manufacturing Holdings's net debt to EBITDA ratio of 3.5, we think its super-low interest cover of 1.3 times is a sign of high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Even worse, American Axle & Manufacturing Holdings saw its EBIT tank 23% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if American Axle & Manufacturing Holdings 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.

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. Over the last three years, American Axle & Manufacturing Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both American Axle & Manufacturing Holdings's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, it seems to us that American Axle & Manufacturing Holdings's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example American Axle & Manufacturing Holdings has 3 warning signs (and 1 which shouldn't be ignored) we think 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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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.