These 4 Measures Indicate That Ampco-Pittsburgh (NYSE:AP) Is Using Debt In A Risky Way

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Ampco-Pittsburgh Corporation (NYSE:AP) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Ampco-Pittsburgh

What Is Ampco-Pittsburgh's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Ampco-Pittsburgh had US$88.9m of debt, an increase on US$77.9m, over one year. However, it does have US$7.89m in cash offsetting this, leading to net debt of about US$81.0m.

How Strong Is Ampco-Pittsburgh's Balance Sheet?

The latest balance sheet data shows that Ampco-Pittsburgh had liabilities of US$124.8m due within a year, and liabilities of US$366.5m falling due after that. Offsetting these obligations, it had cash of US$7.89m as well as receivables valued at US$113.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$370.5m.

This deficit casts a shadow over the US$40.0m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Ampco-Pittsburgh would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Ampco-Pittsburgh's debt to EBITDA ratio (2.8) suggests that it uses some debt, its interest cover is very weak, at 1.0, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that Ampco-Pittsburgh improved its EBIT by 2.8% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ampco-Pittsburgh will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Ampco-Pittsburgh burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Ampco-Pittsburgh's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like Ampco-Pittsburgh has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Ampco-Pittsburgh (1 is a bit concerning) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.