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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Ferroglobe PLC (NASDAQ:GSM) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Ferroglobe's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Ferroglobe had US$500.5m of debt in September 2020, down from US$667.3m, one year before. However, it does have US$121.2m in cash offsetting this, leading to net debt of about US$379.3m.
A Look At Ferroglobe's Liabilities
We can see from the most recent balance sheet that Ferroglobe had liabilities of US$363.1m falling due within a year, and liabilities of US$579.7m due beyond that. Offsetting these obligations, it had cash of US$121.2m as well as receivables valued at US$193.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$627.8m.
This deficit casts a shadow over the US$277.4m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Ferroglobe would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ferroglobe's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Ferroglobe made a loss at the EBIT level, and saw its revenue drop to US$1.2b, which is a fall of 34%. To be frank that doesn't bode well.
Not only did Ferroglobe's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable US$132m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of US$179m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Ferroglobe (of which 1 shouldn't be ignored!) you should know about.
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.
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