Is Warrior Met Coal (NYSE:HCC) Using Too Much Debt?

By
Simply Wall St
Published
January 23, 2022
NYSE:HCC
Source: Shutterstock

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Warrior Met Coal, Inc. (NYSE:HCC) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Warrior Met Coal

What Is Warrior Met Coal's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Warrior Met Coal had US$340.5m of debt in September 2021, down from US$379.7m, one year before. However, because it has a cash reserve of US$276.9m, its net debt is less, at about US$63.6m.

debt-equity-history-analysis
NYSE:HCC Debt to Equity History January 23rd 2022

How Healthy Is Warrior Met Coal's Balance Sheet?

The latest balance sheet data shows that Warrior Met Coal had liabilities of US$134.4m due within a year, and liabilities of US$474.9m falling due after that. Offsetting these obligations, it had cash of US$276.9m as well as receivables valued at US$73.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$259.1m.

Given Warrior Met Coal has a market capitalization of US$1.33b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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

Given net debt is only 0.35 times EBITDA, it is initially surprising to see that Warrior Met Coal's EBIT has low interest coverage of 1.0 times. So one way or the other, it's clear the debt levels are not trivial. Warrior Met Coal grew its EBIT by 2.6% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Warrior Met Coal's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Warrior Met Coal actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Warrior Met Coal's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its interest cover has the opposite effect. All these things considered, it appears that Warrior Met Coal can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. While Warrior Met Coal didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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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