Is Axalta Coating Systems (NYSE:AXTA) A Risky Investment?

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. As with many other companies Axalta Coating Systems Ltd. (NYSE:AXTA) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Axalta Coating Systems

What Is Axalta Coating Systems's Net Debt?

As you can see below, Axalta Coating Systems had US$3.53b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$567.0m in cash offsetting this, leading to net debt of about US$2.96b.

How Healthy Is Axalta Coating Systems' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Axalta Coating Systems had liabilities of US$1.42b due within 12 months and liabilities of US$4.13b due beyond that. Offsetting this, it had US$567.0m in cash and US$1.34b in receivables that were due within 12 months. So its liabilities total US$3.65b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Axalta Coating Systems has a market capitalization of US$8.69b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Axalta Coating Systems has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 3.5 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The good news is that Axalta Coating Systems grew its EBIT a smooth 44% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Axalta Coating Systems 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Axalta Coating Systems produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

When it comes to the balance sheet, the standout positive for Axalta Coating Systems was the fact that it seems able to grow its EBIT confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. When we consider all the elements mentioned above, it seems to us that Axalta Coating Systems is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Case in point: We've spotted 1 warning sign for Axalta Coating Systems you should be aware of.

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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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.