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.' 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 Ferroglobe PLC (NASDAQ:GSM) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Ferroglobe Carry?
The image below, which you can click on for greater detail, shows that Ferroglobe had debt of US$529.7m at the end of December 2020, a reduction from US$580.5m over a year. On the flip side, it has US$103.7m in cash leading to net debt of about US$426.0m.
How Strong Is Ferroglobe's Balance Sheet?
The latest balance sheet data shows that Ferroglobe had liabilities of US$394.9m due within a year, and liabilities of US$575.9m falling due after that. On the other hand, it had cash of US$103.7m and US$257.4m worth of receivables due within a year. So its liabilities total US$609.7m more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's US$597.5m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. 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.
In the last year Ferroglobe had a loss before interest and tax, and actually shrunk its revenue by 29%, to US$1.1b. To be frank that doesn't bode well.
While Ferroglobe's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable US$82m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of US$185m. And until that time we think this is a risky stock. 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. Be aware that Ferroglobe is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...
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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