We Think Albemarle (NYSE:ALB) Can Stay On Top Of Its 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.' 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. We note that Albemarle Corporation (NYSE:ALB) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Albemarle

How Much Debt Does Albemarle Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Albemarle had US$3.54b of debt, an increase on US$3.30b, over one year. On the flip side, it has US$1.60b in cash leading to net debt of about US$1.94b.

How Strong Is Albemarle's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Albemarle had liabilities of US$3.94b due within 12 months and liabilities of US$4.78b due beyond that. Offsetting these obligations, it had cash of US$1.60b as well as receivables valued at US$1.71b due within 12 months. So it has liabilities totalling US$5.41b more than its cash and near-term receivables, combined.

Albemarle has a very large market capitalization of US$14.8b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Albemarle has a low net debt to EBITDA ratio of only 0.74. And its EBIT covers its interest expense a whopping 21.2 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Albemarle grew its EBIT by 20% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Albemarle'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Albemarle reported free cash flow worth 2.2% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

When it comes to the balance sheet, the standout positive for Albemarle was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. In particular, conversion of EBIT to free cash flow gives us cold feet. Considering this range of data points, we think Albemarle is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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 - Albemarle has 1 warning sign we think you should be aware of.

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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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.