Anglo American Platinum (JSE:AMS) Has A Pretty Healthy Balance Sheet

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. We can see that Anglo American Platinum Limited (JSE:AMS) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Anglo American Platinum

What Is Anglo American Platinum's Net Debt?

As you can see below, Anglo American Platinum had R106.0m of debt at June 2022, down from R3.99b a year prior. However, its balance sheet shows it holds R43.1b in cash, so it actually has R43.0b net cash.

How Strong Is Anglo American Platinum's Balance Sheet?

The latest balance sheet data shows that Anglo American Platinum had liabilities of R60.2b due within a year, and liabilities of R18.6b falling due after that. Offsetting this, it had R43.1b in cash and R3.63b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R32.0b.

Of course, Anglo American Platinum has a titanic market capitalization of R338.4b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Anglo American Platinum boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Anglo American Platinum saw its EBIT decline by 3.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Anglo American Platinum'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Anglo American Platinum may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Anglo American Platinum recorded free cash flow worth 68% 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

We could understand if investors are concerned about Anglo American Platinum's liabilities, but we can be reassured by the fact it has has net cash of R43.0b. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in R54b. So we don't have any problem with Anglo American Platinum's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Anglo American Platinum (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.