We Think Alpha Metallurgical Resources (NYSE:AMR) Is Taking Some Risk With Its Debt

Simply Wall St
December 31, 2021
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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Alpha Metallurgical Resources, Inc. (NYSE:AMR) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Alpha Metallurgical Resources

How Much Debt Does Alpha Metallurgical Resources Carry?

You can click the graphic below for the historical numbers, but it shows that Alpha Metallurgical Resources had US$505.2m of debt in September 2021, down from US$591.8m, one year before. However, it does have US$78.3m in cash offsetting this, leading to net debt of about US$426.9m.

NYSE:AMR Debt to Equity History December 31st 2021

A Look At Alpha Metallurgical Resources' Liabilities

According to the last reported balance sheet, Alpha Metallurgical Resources had liabilities of US$292.4m due within 12 months, and liabilities of US$1.14b due beyond 12 months. Offsetting this, it had US$78.3m in cash and US$335.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.01b.

This is a mountain of leverage relative to its market capitalization of US$1.10b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Even though Alpha Metallurgical Resources's debt is only 1.7, its interest cover is really very low at 2.1. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. We also note that Alpha Metallurgical Resources improved its EBIT from a last year's loss to a positive US$148m. 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 Alpha Metallurgical Resources 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. In the last year, Alpha Metallurgical Resources's free cash flow amounted to 21% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Alpha Metallurgical Resources's attempt at covering its interest expense with its EBIT, we're certainly not enthusiastic. But at least its net debt to EBITDA is not so bad. Looking at the bigger picture, it seems clear to us that Alpha Metallurgical Resources's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. For example, we've discovered 2 warning signs for Alpha Metallurgical Resources that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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