These 4 Measures Indicate That Peabody Energy (NYSE:BTU) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Peabody Energy Corporation (NYSE:BTU) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Peabody Energy

How Much Debt Does Peabody Energy Carry?

As you can see below, Peabody Energy had US$313.4m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$772.9m in cash, so it actually has US$459.5m net cash.

How Healthy Is Peabody Energy's Balance Sheet?

We can see from the most recent balance sheet that Peabody Energy had liabilities of US$778.6m falling due within a year, and liabilities of US$1.40b due beyond that. Offsetting this, it had US$772.9m in cash and US$304.2m in receivables that were due within 12 months. So its liabilities total US$1.10b more than the combination of its cash and short-term receivables.

Peabody Energy has a market capitalization of US$2.72b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Peabody Energy also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Peabody Energy if management cannot prevent a repeat of the 59% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Peabody Energy 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Peabody Energy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Peabody Energy recorded free cash flow worth 71% 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

Although Peabody Energy's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$459.5m. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in US$346m. So we are not troubled with Peabody Energy's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Peabody Energy is showing 4 warning signs in our investment analysis , and 1 of those is significant...

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.

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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.