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.' 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 Livent Corporation (NYSE:LTHM) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Livent's Debt?
As you can see below, at the end of December 2020, Livent had US$236.7m of debt, up from US$154.6m a year ago. Click the image for more detail. However, because it has a cash reserve of US$11.6m, its net debt is less, at about US$225.1m.
How Strong Is Livent's Balance Sheet?
We can see from the most recent balance sheet that Livent had liabilities of US$82.3m falling due within a year, and liabilities of US$288.7m due beyond that. Offsetting this, it had US$11.6m in cash and US$111.4m in receivables that were due within 12 months. So its liabilities total US$248.0m more than the combination of its cash and short-term receivables.
Of course, Livent has a market capitalization of US$2.43b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Livent's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Livent made a loss at the EBIT level, and saw its revenue drop to US$288m, which is a fall of 26%. That makes us nervous, to say the least.
Not only did Livent's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost US$11m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$118m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Livent (including 1 which makes us a bit uncomfortable) .
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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