We Think Ternium (NYSE:TX) Can Manage Its Debt With Ease

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.' 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. As with many other companies Ternium S.A. (NYSE:TX) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ternium

What Is Ternium's Debt?

You can click the graphic below for the historical numbers, but it shows that Ternium had US$1.36b of debt in March 2022, down from US$1.70b, one year before. However, its balance sheet shows it holds US$2.92b in cash, so it actually has US$1.56b net cash.

How Strong Is Ternium's Balance Sheet?

The latest balance sheet data shows that Ternium had liabilities of US$2.82b due within a year, and liabilities of US$1.68b falling due after that. Offsetting this, it had US$2.92b in cash and US$2.33b in receivables that were due within 12 months. So it actually has US$750.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Ternium could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Ternium has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Ternium grew its EBIT by 194% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ternium 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Ternium has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Ternium recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Ternium has US$1.56b in net cash and a decent-looking balance sheet. And we liked the look of last year's 194% year-on-year EBIT growth. So we don't think Ternium's use of debt is risky. 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. We've identified 3 warning signs with Ternium (at least 1 which is significant) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.