Is ArcelorMittal South Africa (JSE:ACL) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 ArcelorMittal South Africa Ltd (JSE:ACL) makes use of debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

See our latest analysis for ArcelorMittal South Africa

How Much Debt Does ArcelorMittal South Africa Carry?

You can click the graphic below for the historical numbers, but it shows that ArcelorMittal South Africa had R5.91b of debt in December 2021, down from R6.96b, one year before. However, it does have R4.65b in cash offsetting this, leading to net debt of about R1.26b.

How Healthy Is ArcelorMittal South Africa's Balance Sheet?

We can see from the most recent balance sheet that ArcelorMittal South Africa had liabilities of R14.3b falling due within a year, and liabilities of R5.76b due beyond that. Offsetting these obligations, it had cash of R4.65b as well as receivables valued at R2.71b due within 12 months. So its liabilities total R12.7b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the R6.82b 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'd watch its balance sheet closely, without a doubt. After all, ArcelorMittal South Africa would likely require a major re-capitalisation if it had to pay its creditors today.

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.

ArcelorMittal South Africa has a low net debt to EBITDA ratio of only 0.15. And its EBIT easily covers its interest expense, being 14.2 times the size. So we're pretty relaxed about its super-conservative use of debt. Although ArcelorMittal South Africa made a loss at the EBIT level, last year, it was also good to see that it generated R8.0b in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if ArcelorMittal South Africa can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. In the last year, ArcelorMittal South Africa's free cash flow amounted to 24% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say ArcelorMittal South Africa's level of total liabilities was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making ArcelorMittal South Africa stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. For example ArcelorMittal South Africa has 3 warning signs (and 2 which shouldn't be ignored) we think you should know about.

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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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.