We Think Ampco-Pittsburgh (NYSE:AP) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Ampco-Pittsburgh Corporation (NYSE:AP) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ampco-Pittsburgh

What Is Ampco-Pittsburgh's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Ampco-Pittsburgh had debt of US$25.7m, up from US$11.7m in one year. However, it also had US$12.3m in cash, and so its net debt is US$13.5m.

A Look At Ampco-Pittsburgh's Liabilities

Zooming in on the latest balance sheet data, we can see that Ampco-Pittsburgh had liabilities of US$119.7m due within 12 months and liabilities of US$255.5m due beyond that. Offsetting this, it had US$12.3m in cash and US$83.7m in receivables that were due within 12 months. So it has liabilities totalling US$279.3m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the US$112.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Ampco-Pittsburgh would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Given net debt is only 0.65 times EBITDA, it is initially surprising to see that Ampco-Pittsburgh's EBIT has low interest coverage of 1.00 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, Ampco-Pittsburgh's EBIT fell a jaw-dropping 79% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ampco-Pittsburgh's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last two years, Ampco-Pittsburgh produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

To be frank both Ampco-Pittsburgh's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, it seems to us that Ampco-Pittsburgh's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Ampco-Pittsburgh (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.